Lead managers Deutsche Bank and Goldman Sachs increased the securitisation from the targeted minimum of Eu1.5bn as investors dived for the bonds ? the first new Russian sovereign risk to be sold internationally since the country?s August 1998 default.
The rapturous response shows just how much perceptions of Russia have changed since then. The leads announced the securitisation last week and planned to hold a roadshow all this week, but cut it short on Wednesday when orders topped Eu20bn.
More than 700 investors bought the three tranche deal in euros and dollars, issued through a special purpose vehicle (SPV) established in Germany called Aries Vermögensverwaltungs GmbH.
The transaction is believed to be the German government?s first use of securitisation. It was a manoeuvre to help fund the country?s large budget deficit without raising the national debt. Germany?s budget deficit was 4.2% of GDP in 2003 ? well above the 3% maximum prescribed in the Maastricht Treaty.
The proceeds from the synthetic securitisation of Russian debt cannot be counted as reducing Germany?s budget deficit, but under EU accounting rules the deal will not count as debt, so it will enable Germany to borrow less in the Bund market.
Analysts expect Germany to issue more Russian-linked debt next year. Germany has Eu14bn of Russian Paris Club debt on its books, but the leads say it has committed to keep at least Eu3.5bn of this under all circumstances, to ensure its interests remain aligned with those of the bondholders.
The bond also includes a guarantee that Germany will not issue further Russian-linked debt for at least six months. That means it could bring a similarly sized deal early in 2005.
For bond investors, however, the deal was all about Russia. The face value of the new bonds is just above 20% of the total outstanding Russian Federation Eurobonds and MinFins, valued at $26.8bn.
Investors were offered three bullet tranches ? a three year FRN in euros, a five year euro straight bond and a 10 year fixed rate dollar tranche.
Standard & Poor?s rated the bonds at BB+, at the Russian sovereign ceiling, while Moody?s gave them a Ba2 rating, two notches below its sovereign level of Baa3. The agency views the new deal as junior to the sovereign?s Eurobonds ? one reason why the deal came wider than the sovereign?s secondary curve.
The Eu2bn three year floater was priced at 325bp over Euribor, in the middle of a price guidance range of 300bp-350bp.
The Eu1bn five year deal was priced at a 7.75% yield from a range of 7.75%-8%, and the $2.4355bn 10 year dollar tranche came tighter than the range of 9.625%-9.75% to be priced at 9.6%.
Some bankers suggested the pricing had been generous, although many said secondary performance over the next few days would indicate the accuracy of pricing and the quality of the book.
Some also complained that the leads had shrouded the marketing effort in secrecy, saying investors had no idea of the likely scale of the deal until late on.
?It would not be surprising to see some convergence in pricing between the new deal and the sovereign Eurobonds,? said Ziad Awad, head of frequent borrower syndicate at Goldman Sachs in London. ?Pricing on Aries contained some concession to the sheer size of the deal, as well as a pick-up for the innovative structure and new asset class.?
Spoiling Russia?s curve ...
When news of the securitisation broke a week ago, it knocked the Russian sovereign?s secondary trading levels off course. In the 24 hours after Germany?s announcement last Thursday, Russia?s benchmark 2030 dollar bond widened by 38bp to as much as 330bp over Treasuries, while the sovereign?s credit default swaps widened by up to 50bp.
?We have worked on this deal for many months and in the run-up obviously kept it confidential, because the borrower was focused on the market?s reaction,? said Awad.
?With such an announcement, we expected an underperformance of Russian Eurobonds, and had predicted various scenarios ranging from 25bp-75bp of underperformance. The overall movement that we have seen was for around 30bp, at the low end of our expectations. This was a good sign of the strength of the underlying Russian credit and of the depth of that market.?
The 25bp rise in US interest rates on Wednesday afternoon, in line with market expectations, also encouraged the leads to push ahead, mindful of the US employment data due out today (Friday) and the slow start to next week after the Fourth of July holiday in the US.
?Emerging markets have been through some volatility in the last few months, but the market had turned for the better in recent weeks,? said Zia Huque, head of European and Asian debt syndicate at Deutsche Bank in London.
?Several sovereigns, such as Brazil and Turkey, have successfully sold bonds in the last few weeks. We felt that the timing was appropriate and that demand was there.?
The book for Aries was split UK 38%, US 31%, Germany 4%, Russia 4%, the rest of Europe 17%, and the rest of the world 6%. Money managers took 42%, hedge funds 30%, banks 18% and others, including pension funds and insurance companies, 10%.
Proceeds will flow straight to Germany?s coffers. In return, the government will make a series of payments to the SPV, linked to those it receives from Russia under its Paris Club agreement.
The SPV then passes the payments on to KfW, the German development bank, in a form of asset swap. KfW pays the SPV a cashflow that matches the interest and principal payments required under the bonds. KfW?s exposure will be fully hedged with the lead managers.
... but Russia need not worry
For Russia, the new deal can be interpreted in several ways. Since Russia has not issued international bonds since 1998, the new supply of paper should make little difference to its borrowing plans.
?We believe that Russia will try to control the securitisation process and increase the amount of tradable debt, although the deal should not affect its ability to service external borrowings,? said Alexander Kudrin, fixed income analyst at Troika Dialog in Moscow.
The only risk would come if Russia?s issuance needs changed. ?If Russia is not involved in the process, it might find itself in direct competition with the Paris Club in terms of issuance,? Kudrin said.
?Assume, for example, that it decides to issue new Eurobonds in 2005, just when a Paris Club member opts to issue CLNs linked to Russian debt. With two options available, the interest rates for both will rise.?
Russia also has the option of buying back part of the credit-linked debt in the market. Merrill Lynch research noted this week that by spring next year Russia?s stabilisation fund, which stores excess tax revenue from the oil industry, would reach its target of Rb500bn.
After that, Russia can use 50 cents in every dollar of excess oil revenues to pay back debt. ?With an unchanged oil price, there might be an annualised $5bn-$7bn available for amortisation and buybacks from that point in time onwards,? Merrill argued.
As long as the Russian government remains so cash rich, it would seem to have little to lose from the securitisation programme.
Corporates could be the losers
But the big losers could be Russian corporate borrowers. ?It will not cut down on the availability of international bond funding, it?ll just increase the cost,? said one head of emerging markets syndicate in London. ?If this quasi-sovereign borrower is paying 9.6% at 10 years, what does this mean for the country?s corporates??
The idea of securitising Paris Club debt is not new ? the export credit agencies of France and Italy did it in early 1998 and Italy?s Sace issued again in 2001 ? but Germany?s example may prompt other countries to copy it.
Many emerging market bond specialists, however, doubt that investors would be willing to buy large portions of credit-linked debt from other large Paris Club debtors.
The six largest debtors are Indonesia, Russia, China, India, Nigeria and Egypt. ?Going down the list, the most promising candidate seems to be Poland, with Paris Club debt of $17bn,? said Giancarlo Perasso, global head of emerging markets research at WestLB in London.
?It is an EU member and investment grade country which should be well received by the market, should creditor countries decide to monetise their assets.?
But he questioned whether Poland would consent to such a deal, even though such consent is not legally necessary.
?The Polish authorities would oppose this plan because, unlike Russia which has a surplus, Poland is running a fairly large government deficit and would not be able to buy back the debt, and hence the new securities would have to be placed in the market, probably at a wider spread, thus affecting the sovereign curve and future borrowing costs,? Perasso said.
?It is more likely that the Polish authorities will look for a bilateral deal to reduce their debt burden, as they did in 2001 with the Brazil deal.?
In October 2001, Poland prepaid all its $3.3bn Paris Club debt to cash-strapped Brazil at 74% of face value.
Lead managers JP Morgan and Unicredit Banca Mobiliare will price Zagrebacka Banka?s debut Eurobond early next week. Price talk for the euro denominated five year deal is at 75bp over mid-swaps.
Dubai?s department of civil aviation has appointed Dubai Islamic Bank as lead manager, arranger and bookrunner for a $750m five year sukuk (Islamic leasing bond) to raise funds for the second phase of the expansion of Dubai International Airport.
Serbia has completed negotiations on its debt to the London Club of commercial bank creditors, paving the way for a debut Eurobond later this year, once it has been rated.
Serbia is the last of the republics of the former Yugoslavia to agree a settlement with the London Club, for its debt of $2.6bn.
Serbia?s parliament must now approve the agreement.
