Few recent deals have shaken the capital markets as much as Germany's securitization of E5 billion of Paris Club debt owed to it by the Russian Federation.
The transaction, issued on July 1, creates the biggest emerging markets bond. In addition, it heralds a new way for Germany to manage its fiscal accounts. The deal allows Germany to generate E5 billion in revenues while shifting the risk that
Russian debt represents off its balance sheet.
International investors lapped up the transaction as it gave them exposure to new Russian sovereign debt for the first time since the financial crisis of August 1998. Total orders topped E20 billion, which allowed the lead managers to increase the size of the bond from a minimum target of E3 billion.
The deal came in three tranches in dollars and euros and was issued through a special purpose vehicle established in Germany called Aries Vermogensverwaltungs. “With this transaction, Germany has written capital markets history, underlining its attractiveness as a financial centre,” says Christoph Brand, responsible for the coverage of the public sector in Germany at Goldman Sachs. The US bank arranged the deal with Deutsche Bank.
The tranches include: $2.4 billion of 10-year dollar-denominated bonds, E2 billion of three-year floating-rate notes, and E1 billion of five-year fixed-rate notes. Each tranche was oversubscribed and, in total, more than 700 investors participated.
Russia's payments to Germany are transferred to Aries through amortization payments. Aries makes equivalent payments to KfW, the German development bank. KfW hedges its obligations and then pays Aries money to cover principal and interest payments to bondholders. Bondholders took the risk because, if Germany notifies certain defaults by Russia, they can only recover 20% of the principal on each note. “Aries is an innovative market transaction with a rather complex structure,” says Joerg Asmussen, a director-general within the German finance ministry.
The transaction took a year to plan and put together, says Marzio Keiling, managing director at Deutsche Bank, although when it came to the crunch, the deal was executed relatively swiftly. Its timing was determined by a number of favourable circumstances, most notably stable emerging markets and Russian backing. “Getting the nod from the Russians to agree was probably one of the most crucial elements of the deal,” admits Keiling.
Critics have questioned whether Russia benefited from the securitization. In the 24 hours after Germany's announcement, Russia's benchmark dollar bond widened by 35bp to 330bp over US Treasuries. “There was a lot of talk about a movement in [Russian] spreads before the transaction but the amount they moved on the deal's announcement was smaller than expected,” says Ziad Awad, syndicate manager at Goldman Sachs. “Spreads then rallied greater than expected.”
Keiling says the transaction demonstrated investors' appetite for Russian risk and the country's improving credit outlook: “It was a huge sign of confidence in Russia and the success of its reforms, despite earlier worries about the Yukos situation.” About 20% of investors were first-time buyers of Russian debt. The order book 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 pension funds and insurance companies 10%.
Issuer: Aries Vermogensverwaltungs
Date of launch: July 1, 2004
Total amount: E5 billion
Maturity: Three years; five years; 10 years
Coupon: Libor + 325bp; 7.75%; 9.60%
Credit ratings: Ba2 (Moody's); BB+ (S&P)
Lead managers: Deutsche Bank, Goldman Sachs