Pioneering, innovative and game-changing. These were just some of the positive expressions of support that MTN marketeers gave to the deal struck in 2008 for Spanish utility Iberdrola to outsource its structured note funding to Catalan bank Banesto in a plan to increase its issuance of low-cost MTNs.
But two years on, the the idea of layering market risk on credit risk appears even more ambitious we are after all in the midst of a eurozone sovereign debt crisis in which Spain, and its companies, banks and regions, have all been caught. Structured note issuance has collapsed and investors are seeking out safety not yield.
Why then did Generalitat de Catalunya in May join Iberdrola in outsourcing its structured note funding to Banesto, becoming the first regional issuer to try the innovative idea? Although dealers have welcomed the idea for the widened scope and flexibility of what GenCat can now offer, they are less bullish than in 2008 in terms of how far the doors of structured funding will now open for the region.
Since Lehman Brothers collapsed, investors have been baying for more corporate and SSA issuers to become involved in the MTN market, not only in vanilla format, but also to issue structured notes. In the aftermath of September 2008, investors have become conscious of the need to eliminate credit risk, and especially financial credit risk, from the few structured notes that are being traded in the private placement market. But as Spain has been under siege from worried investors since the start of the year, Spanish regional credit is considered far from risk free. GenCats secondary trading levels have moved out by 200bps since the start of the eurozone crisis.
"Its a good idea what they have done in terms of operation, and widening your investor base is of course helpful, but the timing is probably not ideal as many investors are at the moment very risk averse towards Spain," says Konrad Merkofer, executive director on the MTN desk at UBS in London. "The private placement levels for GenCat look attractive but for many international investors it is not a question of pricing, they simply dont want to increase the exposure at the moment."
GenCat has put in place a Eu9bn EMTN programme from which the GenCat-Banesto structured and vanilla notes will be issued with a minimum size for of Eu1m and a maximum of Eu25m.GenCats private placement levels offer investors around a 100bp pick-up over the Kingdom of Spains secondary curve, although the pricing of individual MTNs will vary depending on the size of the deal and the structure.
At the start of June, five year GenCat benchmark paper was trading around 230bp over mid-swaps, the Kingdom of Spain was trading around 170bp over mid-swaps and the five year funding level for GenCat was offering around 250bp-260bp over mid-swaps.
Dealers are positive about the move, even if there is concern about the timing of the launch.
"Its a good strategy for GenCat to make this move with Banesto, as it will greatly increase the speed of the enquiries and flexibility of GenCat in terms of structures they can handle in the MTN market," says Julie Pertuiset, executive director on the MTN desk at Conduit Capital Markets. "Iberdrola started a similar scheme with Banesto and because of that they are now considered to be the easiest corporate to deal with in the MTN market in terms of process, quick reaction to enquiries and mandates."
As with the arrangement that was reached with Iberdrola in May 2008, the intention is to use Banestos larger front and back office platform for coping with structured note enquiries and valuations to allow investors access to small structured notes from an issuer that doesnt have its own ability to handle the trading of small, sometimes highly structured trades.
GenCat has four people in its front office funding team, with a further two in the back office, but that team deals not only with MTNs but also benchmark deals, Schuldscheine and short term funding. By contrast, Banesto has more than 15 people focused exclusively on the MTN market, and it is that larger team effort that GenCat hopes to harness.
"The only real difference between the arrangement with Iberdrola and GenCat is that with GenCat trades are done from an existing programme, issued directly from the Government of Catalonia whereas with Iberdrola, the issuer is a vehicle that has an EMTN programme fully guaranteed by Iberdrola," says Wafi Saleh, head of structured funding and EMTNS at Banesto in Madrid. "Operationally our dealings with the two issuers are very similar."
GenCat will issue in 11 leading currencies, with all proceeds swapped to euros.
The notes will also have minimum denominations of Eu1,000, opening the issuer up to retail investors, which it has not historically targeted via the MTN market.
"GenCat is one of the Spanish regions with higher funding needs, so it is understandable that they try to open additional routes compared to the others. It makes sense that they would go down to Eu1m size trades and be more open to doing structures," said Merkofer.
But MTN dealers are unsure of how successful such a push can be with investors running scared of Spanish risk, and Banesto says that the retail market is not the focus of the new arrangement.
"Despite the minimum denomination size, were not particularly targeting the retail market its very much a wholesale programme," said Saleh.
Generalitat de Catalunya is rated A1/ A+/A+ on negative watch with all three agencies. The region has total debt of Eu9bn to raise in 2010, but there is a government stability programme being put in place to help with that amount, so the final figure will be lower. As one of the largest regions in Spain, GenCat has one of the largest financing needs, but both Banesto and GenCat insist that the timing of the launch of this programme is unrelated to that funding need.
GenCat has so far raised Eu3.8bn on its own this year Eu1bn worth of loans, two public benchmark issues amounting to Eu2.1bn and the remainder, around Eu700m, in private placements.
"We have been working with them for around two years on this it was just coincidental with the timing of coming out with the launch of this new idea, it is not a move by GenCat to maximise its funding capabilities specifically now," says Saleh. "GenCat does have to do funding, and this would help, but this isnt why weve come out with this scheme. This scheme for GenCat is not intended for big volume, rather, it is intended as instrument of efficient and complementary funding."
Jordi Ayala, global debt co-ordinator EMTNs, at the directorate general for financial policy and insurance for the government of Catalonia, says that the move is more of an expansion of GenCats capabilities for the purposes of diversifying funding sources rather than an emergency funding tool.
"With the infrastructure we have in place in our funding team, we could not reach all the investors we wanted, so for the last year and a half weve been working on this new arrangement with Banesto. It helps for us to have another funding instrument to use, but the implementation of it now has nothing at all to do with the crisis," he says.
"We want to do as much as possible via this arrangement with Banesto, but were expecting to do around Eu200m-Eu300m over the next year the target is modest because of the market conditions."
GenCat can now issue the most popular structured notes, including CMS, inflation, commodity and equity-linked deals, and will consider both principal and non-principal protected notes. In the past, the issuer has traded CMS-linked notes and inflation-linked on its own, but enquiries for less than Eu25m were not entertained, as the team focused on vanilla deals in larger sizes. The issuer does, however, have some limits with regards to what notes is will issue from a reputational point of view, particularly with regards to credit-linked notes.
"As a public administration, we cant issue deals linked to sub-investment grade companies were very careful in that respect, but Banesto also avoids these trades as well, so in terms of reputational risk, what we are willing to issue is very similar to what Banesto itself would issue," he says.
GenCat will also abstain from trading callable deals because a laborious authorisation process to approve chunks of funding makes it inefficient to issue this type of note. This will cut it off from the callable zero and callable range accrual market which has constituted the majority of activity in the structured MTN market since Lehmans collapse.
However, the notes will be much easier for MTN dealers to place as they will have Banesto as their swap counterparty, which in turn will then face Generalitat de Catalunya in the swap. Many dealers have swap lines open with Banesto but not with GenCat, so this makes it easier to complete the trade.
Generalitat de Catalunyas first and only MTN with Banesto acting on behalf of the issuers funding department is a Eu1.5m five year equity-linked note via BBVA, sold at the start of June. The redemption and coupon on the note are linked to the performance of a single blue chip company stock.
But some dealers say enquiry for GenCat is increasing and the name is being shown regularly for small structured notes.
"We are being very active on quotes for GenCat, but the hit rate is quite low. The bidding for hybrid, CMS and equity-linked notes is very competitive at the moment, however the volatility in the market is hitting structured product volumes hard," says Saleh.
Other dealers say that enquiry for issuers in the eurozone is still very low, especially for those in the hardest hit countries such as Spain, Portugal and Greece.
"Were seeing very little enquiry for any Spanish or Portuguese issuer. Its not even a case of pricing, investors just want to stay away from those names, full stop," said Pertuiset. "GenCat will likely not see a large amount of enquiry until confidence in Spain starts to return."
Saleh remains cagey on whether Iberdrola or GenCat are paying fees to Banesto for this service, saying only that the arrangement is for relationship reasons. However the collaboration with GenCat could be the last step for Banesto in offering its services to other corporate and regional investors wanting to tap the structured note market.
"The clearly differentiated profiles for GenCat, a high single-A regional authority, Banesto, a double-A financial, and Iberdrola a low single-A global corporate, allows us to manage the funding of all three without a conflict of interest," says Saleh. "We have no current plans to expand this scheme further with other issuers, to avoid managing issuers that are competing with each other. For now we are satisfied with what we have done."
The arrangements made with Banesto may yield only light volumes of additional funding for Iberdrola and GenCat while both the structured note market and Spanish demand remains crippled. But when these markets do return, Iberdrola and GenCat will be among the first non-financial institutions in line to take advantage of the change.