The euro: separating hype from reality

  • 01 Apr 1999
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The birth of the euro has provided a natural new funding source for central and eastern European borrowers -- especially those from the EU accession states -- at a time when issuance in the dollar market has been complicated by US investor nervousness in the wake of the Russian crisis.
The new single currency offers access to investors throughout Europe -- who, thanks to their geographical proximity, are bound to have a more rounded view of credits from the region than their UJS counterparts. The result: cheaper financing, better end-investor distribution and general happiness all round.
That, at least, is the marketing hype from investment bankers. The reality appears to be somewhat different. Despite a number of sovereign euro issues from the region since January -- and a welter more in the pipeline -- few have so far managed to shine.
And there is a growing view that the virtues of the embryonic euro sector have been over-promoted -- and that the tried and tested dollar market may be a better bet for many of the region's borrowers. Guy Norton reports.

The introduction in January of the euro and creation of the single European currency bond market promised to open up central and eastern European bond issuance to a wider investor base than ever before.

Sovereign issuers from the region have proved especially keen to tap the new currency to promote their EU accession credentials.

Indeed, this year for the first time ever all the leading EU 'wannabe states' could be present in the international bond markets, with most opting for the euro as their preferred funding currency.

Four sovereign borrowers -- Hungary, Croatia, Slovenia and Lithuania -- have already done so, while the Czech Republic, Estonia, Latvia, Poland and Slovakia are widely expected to follow suit later in the year.

Even single-B rated credits like Bulgaria and Romania are being touted as outside bets in the region's race to raise funds in the currency.

So far at least, though, the optimism -- cynics might say hype -- surrounding the region has failed to translate into blow-out successes for the sovereign issues which have been launched in the euro.

Arguably, the most successful of the transactions to date was the first of the year -- Hungary's Eu500m February 16, 2009 bond . Although the transaction was the first under the title of the Republic of Hungary, thanks to the past efforts of the National Bank of Hungary (NBH) it was one with an impeccable provenance.

In 1998, in its last year as the fiscal agent of the Hungarian state, the NBH was undoubtedly the star sovereign borrower from the region, successfully leveraging its reputation as the region's most sophisticated and best known issuer to secure $1.65bn of funds in Deutschmarks and dollars at highly competitive rates.

Hungary's strong macroeconomic track record over a testing year played a major role in that performance and meant against an emerging market background where rating downgrades were the norm, Hungary earned the rare distinction of being upgraded by both major ratings agencies. Moody's Investors Service upped it to Baa2 from Baa3 and Standard & Poor's raised it to BBB from BBB-.

In a classic example of the early bird catching the worm, the speed with which officials at the AKK -- the government debt management agency which has assumed the NBH's international funding duties -- moved to capitalise on the favourable issuance conditions in January showed that it has also the savoir-faire traditionally exhibited by the NBH.

Recognising, but more importantly reacting to, a favourable funding opportunity meant that the Hungarians were able to maximise the distribution and minimise the funding costs of the issue, say bankers.

"Timing is everything. Being first out of the blocks this year was central to Hungary's success. The issue benefited from the euphoria surrounding the successful launch of the euro and the positive sentiment surrounding Hungary's credit story. The market environment is much more challenging now," acknowledges Richard Luddington, global head of emerging market debt syndicate at JP Morgan, which jointly lead managed the issue alongside Germany's DG Bank.

The two banks secured the prestigious mandate after a competitive bidding process which involved at least 25 banks.

The transaction was the first issued in the name of the Republic of Hungary itself and at Eu500m and 10 years it was the first -- and to date only -- true benchmark offering in euros from central and eastern Europe.

Sentiment towards the issue pre-launch was boosted by a series of better than expected economic releases which showed that the country had largely escaped any ill effects from the Russian crisis. So, despite the distraction of the recent devaluation of the Brazilian real -- which had hit sentiment towards emerging market issuance in general and at one point threatened to completely derail the funding plans of central and eastern European sovereign borrowers -- the offering was well received by the target audience of institutional investors.

Featuring a punchy looking 4.375% headline coupon, the landmark transaction was priced to yield 4.51% and a spread of 87bp over the 3.75% January 2009 Bund on a fixed price re-offer of 98.924 and an all-in level of 92bp.

That was described as a "tight but right" level by the lead managers, who pointed to Hungary's solid investment grade ratings, its status as a fast track candidate for entry to the EU and its membership of the OECD -- which means its issuance is zero risk weighted -- as justifications for the pricing.

In the post-Russian crisis era when investors are keen to minimise having to provision against holding risk, that latter feature is a definite bonus.

"Its zero risk weighting has clearly helped Hungary in Europe where it's a major factor for a lot of investors, especially banks," says Reid Payne, global head of emerging markets debt syndicate at ABN Amro.

Unsurprisingly, however, given the fierce competition to secure the prized mandate there was criticism from rival bankers. They claimed that the consensus all-in range for the issue had been 95bp-103bp over Bunds and that a result of the overaggressive pricing the issue failed to achieve the pan-European distribution the Hungarians were seeking.

Others complained that the issue was priced through the existing Hungarian yield curve in Deutschmarks -- the NBH's DM500m 4.625% seven year issue from December 1998 was trading bid at 85bp over Bunds.

The leads were quick to refute accusations of narrow placement, however, reporting that they had placed bonds with institutions in the UK and across the continent as well as to Asian and offshore US accounts.

They also said that illiquid Euromarket issues from the National Bank of Hungary were imperfect pricing reference points for the transaction, which as the first for the Republic of Hungary had a special cachet.

Says Patrick Götzinger, vice president investment banking at DG Bank: "We believe that Hungary should be judged against EU rather than emerging market sovereigns. The most relevant pricing comparison at the time was therefore the Baa1/BBB rated Hellenic Republic's Eu2bn 5.75% March 31, 2008 transaction, which was trading almost 30bp tighter at 58bp over the 5.25% April 2008 OAT at the time of launch.

"On a swapped basis the Hungary issue also offered value at 48bp over Euribor -- an 18bp pick-up over the 30bp trading margin for the Hellenic Republic."

Despite sniping about the pricing in aftermarket trading the Hungary issue tightened in over the next few weeks and was trading bid at 85bp over Bunds at the end of February when the Republic of Croatia became the next sovereign from the region to tap the sector.

By then, however, the issuance environment for central and eastern European credits had already begun to change -- for the worse.

A faltering economic performance in the 11 EU countries which make up the eurozone had led to weakness in the foreign exchange performance of the euro, particularly against the dollar. Combined with rising fears of global interest rate volatility, the euro's weakness complicated the task of lead mangers Credit Suisse First Boston and Dresdner Kleinwort Benson.

Nevertheless by embarking on an extensive roadshow in seven European money centres -- Vienna, Zurich, Frankfurt, Paris, Milan, Madrid and London -- the leads were able to drum up interest among European institutions and build a solid book of demand for the Baa3/BBB- sovereign which resulted in the launch of a Eu300m 7.375% seven year issue -- versus an original Eu250m issue size and a five to seven year tenor range.

Having successfully launched Croatia's largest ever international bond the leads were therefore arguably justified in claiming the deal as a success.

Carsten Stoehr, director and co-head of emerging European debt capital markets at CSFB, commented at the time: "We're very happy with the deal which was larger in size and longer in tenor than originally planned, and was fully sold at launch."

Europe's risk-averse institutional investors did, however, demand a price for their participation, with the result that the issue was priced to give a yield of 7.45% and a spread of 375bp over the 6% February 2006 Bund -- versus indicative pricing of 325bp-350bp.

Although the re-offer margin was the highest ever paid by the Croatians in the Euromarkets it did compare favourably with the secondary market spreads on Croatia's outstanding Eurobonds -- including a $300m 7% February 2002 issue from February 1997 trading at 380bp and a DM300m 6.125% July 2004 issue from July 1997 at 320bp at the time.

Furthermore, the leads could at least comfort the Croatians with the knowledge that they had paid far less for market access than the 650bp spread similarly rated Colombia was proposing to pay for a five year euro issue. That deal failed to get off the ground due to investor fears over the economic travails in Latin America.

Hrvoje Radovanic, Croatia's assistant minister of finance told Euroweek at the time: "We are happy that we have achieved our goals both in terms of issue size and tenor and also in terms of the quality and breadth of distribution."

While most syndicate members conceded that Croatia had achieved its goal of securing pan-European distribution for the issue -- which is expected to be the country's sole public Eurobond offering this year -- a number noted that Croatia had ultimately failed to exorcise the ghosts of its political past that continue to haunt its impressive high growth, low inflation macroeconomic track record.

"There's no doubt that Croatia still suffers by association with the unsettled political situation in the former Yugoslavia," noted one US banker at the time.

For Croatia that has proved a prescient observation as the country's Balkan connections have hit secondary market performance of the issue, which quickly traded out to 385bp in the first week and which has since widened out to over 455bp on the back of nervousness over Nato's action against Croatia's neighbour Serbia.

For Pascal Najadi, director and head of new issue debt origination for at Dresdner Kleinwort Benson, the current military conflict has masked Croatia's compelling credit story. "Croatia is misunderstood and undervalued, but it's a country with true potential," he says.

Challenging market conditions -- including fears about interest rate hikes in the US and the impact that might have on emerging market economies -- meant that even central and eastern Europe's top rated sovereign, the A3/A rated Republic of Slovenia, had to fight hard to secure investor sponsorship and to preserve its pricing leadership in the region when it came to market in early March with a Eu400m 10 year issue.

Lead managed by Credit Suisse First Boston and Morgan Stanley, the transaction featured a 4.875% coupon to give a margin of 86bp over the 3.75% January 2009 Bund at the issue/fixed re-offer price of 99.165.

Although that was at the bottom end of the 86bp-89bp official pricing range and a psychologically important basis point inside the 87bp launch spread on Baa2/BBB rated Hungary's Eu500m 10 year offering in late January, it was seen as at least 5bp wider than where the issue could have been priced earlier in the year.

For the issuer, however, the 86bp launch spread still represented a success. Valter Rescic, Slovenia's state secretary of finance, told Euroweek: "At the time when we issued, this was the best price we could achieve given the volatile market conditions. We are delighted with the feedback from investors and the media coverage of the issue."

He also pointed out that the transaction continues the positive trend of Slovenia's Euromarket issuance characterised by progressively lower coupons and longer tenors -- following a $325m 7% five year transaction in July 1996, a DM400m 5.75% seven year deal in May 1997 and a Eu500m 5.375% seven year bond in May 1998, which was the first euro issue by an EU fast track candidate.

Unlike those earlier transactions, however, which were launched under bull market conditions, the latest Slovenian offering had to contend with bearish investor sentiment which meant its non-OECD status became an issue for the first time.

"The lack of an OECD risk weighting was clearly a constraint in the Slovenia pricing. A lot of investors, in Germany in particular, won't buy non-OECD sovereign bonds," says JP Morgan's Luddington.

The risk weighting issue was one the Slovenians recognised, however. "We looked to target risk-weighting insensitive institutions," says the finance ministry's Rescic.

Consequently, only 16% of the lead managers' combined Eu360m ticket went to banks -- generally the most risk weighting sensitive investor group -- with the bulk, 62%, going to asset and fund managers, followed by 14% insurance companies and retail 8%.

"We're very happy with the way the deal went," said CSFB's Carsten Stoehr. "We achieved the size, maturity profile, investor distribution and cost effective funding that the Slovenian authorities were looking for."

Just over half the leads' distribution was split between three centres -- Germany, the Benelux and the UK -- but there were also solid contributions from Switzerland, France, Austria and Italy, as well as some Asian and US offshore participation.

"Slovenia is a good way to enter the market for central and eastern European debt -- it's a conservative play but one which still offers a yield pick-up," says one Swiss fund manager.

But although bankers acknowledge the attraction of Slovenia's credit story -- which combines the best ratings in central and eastern Europe with EU and EMU convergence potential -- some question whether Slovenia represents a core holding in the region.

"Small may be beautiful in some people's eyes but at the end of the day Slovenia, with a population of less than 2m, is just that -- small. This issue wasn't a must-have bond for a lot of investors," says a US banker.

Another criticism of the issue was its timing -- it was launched just before the announcement of the US non-farm payroll figure, a key driver of bond market sentiment.

Critics say that by bringing the issue into the uncertain market environment before the data release, the leads failed to maximise the potential investor appetite for the transaction.

The deal's supporters, however, felt that by launching before the release of the ultimately bond-friendly US number, the leads had enabled the issue to capitalise fully on improved investor sentiment.

However. with Eurobonds lagging the Bunds rally that followed the news of the US number, the Slovenia issue widened out to 89bp/87bp in the first week's trading and by Easter was trading bid/offered at 93bp/91bp.

The proceeds from the transaction, set to be Slovenia's sole Euromarket offering of 1999, have been earmarked partly for prepayment and restructuring of existing debt and partly for budget deficit financing purposes. Slovenia's next foray in the international markets is set to emerge in either the Yankee or Samurai bond markets.

Slovenia's travails, however, were ultimately as nothing compared to those of Lithuania, which made its debut in euros at the end of March with a Eu200m five year Euro/144A offering via Credit Suisse First Boston and Dresdner Kleinwort Benson.

Unsettled market conditions had stymied the transaction's launch for several weeks. "This deal had more false starts than a 100 metres sprint final," said one banker, who claimed the delays had destroyed the momentum behind the transaction.

Nevertheless, with CSFB and Dresdner having achieved the borrower's issue size and maturity targets and placing their allocations on day one, the leads felt justified in claiming that their decision to press on with the transaction had been vindicated.

"While somewhat long in coming the issue proved a success. As expected European institutions took the lead with US and Middle Eastern accounts providing a welcome additional bid," said Peter Malik, co-head of emerging European debt capital markets at CSFB.

With an 8% headline coupon, a yield of 8.19% and a spread of 475bp over the 6.25% March 2004 Treuhand the issue proved a more expensive than expected piece of funding for the Lithuanians -- pricing well outside the 400bp-425bp spread talk mooted in February.

Syndicate members acknowledged, however, that in view of the market volatility at the time the Lithuanians had been wise to be flexible on pricing to ensure firm placement.

Importantly, the issue was seen as attractively priced compared to the country's only other major outstanding issue -- the $200m 7.125% July 2002 offering from July 1997 trading bid at 417bp over US Treasuries at the time -- and Baa3/BBB- rated Croatia's Eu300m 7.375% seven year transaction from late February quoted at 400bp over Bunds.

Driven by the bid out of Europe -- where Germany, Switzerland and the Benelux were the main centres of demand -- the deal was notable for attracting 13% of the leads' blended placement with US accounts.

This said the deal's supporters justified the inclusion of the deal's 144A option and pointed to the fact that some US fund managers are looking to diversify out of high risk Latin America issues into lower risk, but still high yielding central and eastern European ones.

Europe and the Middle East accounted for the 87% balance.

Although the issue opened 3bp tighter on the first day, in common with the other sovereign issues from the region it widened on news of the Nato air strikes against Serbia in late March and traded out to 490bp/485bp bid/offered at the end of the first week's trading. By the first week in April, it was languishing at 500bp over.

Undeterred by the less than overwhelming reception to the issues so far launched, the central and eastern European sovereign bandwagon in euros continues to trundle forward.

The Republic of Latvia is set to be the next sovereign from the Baltics to try its luck, with the launch of a Eu150m five year issue which the Baa2/BBB issuer has mandated to CSFB.

The launch of what will be the republic's first international bond has been timetabled for May, following investor presentations in Zurich, Vienna, Frankfurt and London in late April. Unofficial price talk is 225bp-250bp over.

The proceeds of the issue will likely be used to cover a shortfall in the budget, caused by lower revenues as a result of a slowdown in the economy because of the Russian economy.

The Baa1 rated Republic of Estonia, the only one of the Baltic countries to be part of the first wave of EU entrants from central and eastern Europe, is also being tipped as a likely euro issuer.

A mandate is unlikely to be forthcoming for several weeks, however, given that a new government has only recently been formed following general elections in March.

Two of the most keenly awaited euro issues from the region will come from the Slovak Republic and Poland.

At the end of March Credit Suisse First Boston and JP Morgan were confirmed as the lead managers for the debut euro offering by Slovakia. The two banks beat off competition from 14 others to secure the prized mandate.

Although the ratings outlook for Slovakia has deteriorated over the last 18 months, with the country slipping from Baa3/BBB- to Ba1/BB+ on the back of a faltering economic performance, the replacement of the nationalistic, statist government of Vladimir Meciar by a pro-EU, pro-reform coalition last October has led to a change in investor sentiment towards the country.

"Slovakia is a good story based on economic and political turnaround potential, " says JP Morgan's Luddington.

The issue is expected to be launched after the Slovak presidential elections. The first round in the contest will be held on May 15, with a second round scheduled for May 29 if there is not a conclusive result -- which would need a candidate to secure more than 50% of the votes first time around.

Given that Slovakia's credit story will need careful handling in the premarketing phase the issue may not emerge until the middle of June.

Although Slovak officials have talked of a Eu300m-Eu500m issue with a five to seven year tenor, bankers at CSFB and JP Morgan say that the only certainty so far is that the bond will emerge for a minimum issue size of Eu300m -- but that the final amount and maturity will be determined by the level of investor demand.

Market participants say Slovakia will likely need to pay a launch spread in the 425bp-450bp area over the euro government bond benchmark, depending on the issue's eventual size and tenor.

In terms of the country's outstanding issuance, the most relevant pricing reference point for the issue is the DM1bn 8% May 28, 2003 issue, trading around 400bp over Bunds. That issue formed part of a Nomura-led multi-tranche bond financing package which also included a ¥15bn 4% three year transaction and a $300m 9.50% five year offering.

Poland, meanwhile, is poised to shortlist four to six banks from an initial group of 18 bidders on a probable Eu400m issue in the near future. The transaction will be the first international bond by the Baa3/BBB- rated sovereign since a dual tranche $400m 20 and seven year Yankee offering in June 1997.

Polish officials are thought to have requested proposals for deals with five, seven or 10 year tenors -- with a 10 year issue widely considered the Poles' preferred option.

With Poland not having issued in the Euromarkets since the launch of a DM250m 6.125% five year bond in July 1996, market speculation is that the well regarded sovereign's scarcity value and the strategic value of its issuance may enable it to better the pricing levels achieved by better rated Hungary and Slovenia, calmer market conditions permitting.

A key aspect of the transaction is set to be the fact that, with effect from April, Poland's bonds will be treated as zero risk weighted.

But the most closely watched of the potential euro issues will be the planned offering by the Baa1/A- rated Czech Republic.

Central and eastern Europe's erstwhile flagship economy has hit the rocks. Mired in a deepening recession, burdened with a currency widely regarded as overvalued and faced with the bleak prospect of a widening current account and fiscal deficit, the country is facing its greatest economic challenge since independence.

It has already received a warning from the rating agencies, with Standard & Poor's cutting its sovereign foreign currency debt rating to A- from A in early November. Bankers warn that if the government fails to act quickly to shore up investor confidence in the country, S&P's move could be the first step in a downward ratings spiral.

What is more, at a time when the Czech authorities need to have a firm hand on the tiller, the Milos Zeman-led coalition government which replaced the Vaclav Klaus stewarded administration in June 1998 is displaying a distinct lack of seamanship.

In February the Czech finance ministry incurred the wrath of a large section of the central and eastern Europe debt underwriting community when it emerged that it had awarded Morgan Stanley Dean Witter a mandate to arrange a debut Euro-MTN programme for the sovereign -- apparently back in November.

By not conducting a public tender for the prestigious facility, long coveted by a large number of houses, the Czechs angered bankers over the lack of consultation and transparency surrounding the process.

While even Morgan Stanley's arch rivals are willing to concede the US investment bank is free of any blame in the matter -- admitting privately that the US bank's origination team had executed a stunning coup de main -- they have reserved their ire for the Czech finance ministry, which they accuse of acting against international good practice.

The outcry was such that the ministry eventually felt duty bound to publicly explain its actions, claiming it had acted in good faith at all times.

However, the ministry's rather lame defence that it had not opened up the process for fear it would be heavily lobbied by a large number of banks and swamped by offers, cuts little ice with the investment bankers who cover the region.

They view the lack of transparency surrounding the award of the Euro-MTN mandate as being symptomatic of deeper ills within the Czech Republic's business culture.

Bankers say they are increasingly losing patience with the cronyistic attitudes which they claim have increasingly come to characterise the country.

Whatever the relative merits or faults of the selection process for the mandate, the Czech authorities can ill afford to alienate international banks at a time when they have arguably never need their help more.

Vital to the outside world's perception of the country this year will be the success -- or failure -- of the government to privatise a number of the leading state-owned banks. These are saddled with a crippling burden of non-performing loans -- many the result of ill-judged lending in the heady days of the mid-1990s.

The setting up of the Euro-MTN programmed is a key part of that process, with the debt issuance shelf giving the Czech government the flexibility to raise funds internationally if or when they should be required to help ease that process.

Consequently the first issue off the facility will be watched for indications of the strength of support for the country from market professionals and investors.

The transaction will mark the debut of the Czech Republic under its own name, with the finance ministry having assumed responsibility for funding from the Czech National Bank which historically has acted as the sovereign's fiscal agent.

Bankers are already mischievously tipping the investor presentations for such a deal as one of this year's potentially most absorbing pieces of Euromarket theatre. With relations between the experienced hands at the central bank and the recently installed officials at the finance ministry widely described as sub-zero at best, the marketing roadshow will provide a stern test for a sovereign which needs to present a united front.

Reports in the Czech press earlier in the year suggested the Czechs were looking to inaugurate the programme with a Eu150m-Eu200m five to seven year bond. But, with the Czech finance ministry recently maintaining a strict silence over the issue, the final form of any transaction remains uncertain.

Finally, B2/B rated Bulgaria and B3/B Romania are widely considered to be the dark horses in the region's race to fund in euros.

Of the two, Bulgaria is the more likely candidate. Market participants say that Bulgaria could profit from the perception that it is an improving credit, albeit a lowly rated one.

Having threatened to topple into an economic abyss in 1996, the country has made impressive progress since 1997 under a IMF-sponsored programme which has delivered currency stability, seen inflation cut to 15% from over 1,000% and the government's budget deficit pared to near balance from a 3% deficit in 1997.

JP Morgan and Merrill Lynch have a long-standing mandate to lead manage Bulgaria's debut Eurobond which was originally expected to be a five year dollar issue for up to $300m.

Amid the mood of europhoria at the start of the year, however, there was speculation that Bulgaria might opt for a transaction in euros instead.

But with the euro sector proving an increasingly reluctant source of funding for central and eastern Europe, bankers believe Bulgaria is better off sticking with its original plans for a dollar transaction. This at the very least would have the advantage of offering an alternative to the slew of euro offerings.

IIn contrast to the improving outlook for Bulgaria, the perception of Romania's creditworthiness has nosedived over the past year, with the country's ratings slumping from Ba3/BB- to an altogether more shabby looking B3/B-.

Recent comments by Romanian finance officials that they would like to revive their plans for a $250m equivalent five year euro offering mandated to Deutsche Bank and JP Morgan last June have been treated with scepticism by market participants.

Most bankers agree that Romanian authorities would be best advised concentrating on how to find the funds to redeem the ¥52bn 5.2% Samurai and $225m 9.75% Eurodollar National Bank of Romania issues which mature on May 28 and June 25 respectively, as well as make the DM46.5m coupon payment on June 17 for the Republic of Romania's DM600m 7.75% June 2002.

Consequently, many observers regard talk of a euro deal in the third quarter as more of a pipedream rather than a pipeline of issues. EW

  • 01 Apr 1999

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 JPMorgan 317,793.98 1355 8.72%
2 Citi 301,114.13 1092 8.26%
3 Barclays 259,580.63 846 7.12%
4 Bank of America Merrill Lynch 258,842.43 934 7.10%
5 HSBC 224,273.23 905 6.15%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 18 Oct 2016
1 JPMorgan 29,669.98 55 6.95%
2 UniCredit 28,692.62 136 6.73%
3 BNP Paribas 28,431.90 139 6.66%
4 HSBC 22,935.49 112 5.38%
5 ING 18,645.88 118 4.37%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 18 Oct 2016
1 JPMorgan 14,593.71 79 10.38%
2 Goldman Sachs 11,713.19 63 8.33%
3 Morgan Stanley 9,435.23 48 6.71%
4 Bank of America Merrill Lynch 9,019.27 40 6.41%
5 UBS 8,763.73 42 6.23%