Lead-managers for emerging-market borrowers: How many cooks?

"We are well aware that some competitors are bad-mouthing the deal," says Hrvoje Radovanic. "Maybe the situation in Albania did not help. But who knows what investors think?" Radovanic is obviously a puzzled borrower. As assistant to Croatia's finance minister he was instrumental in bringing the former Yugoslav state to the Euromarket. But he can't be particularly happy with the result. The republic's $300 million debut issue in February performed poorly and quickly widened from a launch spread of 80 basis points over treasuries to 135bp over.

Croatia is one of many new issuers recently attracted to the bond market. But for a first-time emerging market borrower it can be a brutal experience. A bad first issue, like Croatia's, sullies its profile and makes future issuance tougher and more expensive.

Croatia's mistake was possibly to award its debut issue to two lead-managers. On a deal of this size it was an unusual step. Two leads are not necessarily better than one. There is less accountability and, when things go badly, joint leads can discredit one other.

Some market participants argue a better strategy is for the debut borrower to build up a relationship of trust with just one house. This is the way Poland, Slovenia, Kazakhstan and other reforming states came to market. Since the beginning of 1996, 87% of first-time borrowers from the emerging markets have mandated just one lead-manager.

After participating in the Croatia deal, one US fund manager told Euromoney he was so upset he would never buy a joint-led emerging market deal again.

"Clearly the sole lead is the way to go," says Bill Battey, head of CSFB's New York syndicate. He remembers bringing to market in 1994 a $500 million issue for Korea Development Bank (not a debut) at a bad time. "When we launched KDB there was an atomic bomb over Seoul on the cover of Time magazine," he says. "We worked for them. We were directly responsible. There was one place to go to buy or sell bonds ­ us. Both the issuer and the buyer got the benefit of that accountability."

It's not just accountability they gain. Brian Mooyaart, a former banker who runs Mooyaart Consult and spends his life analyzing after-market performance using a proprietary model called Quits, thinks pricing is worse in joint-led deals too. "Joint leads tend to be more mispriced," says Mooyaart. "This problem is exacerbated in emerging markets."

In contrast with Croatia's experience ­ where the joint leads were Merrill Lynch and UBS ­ the Sultanate of Oman's $225 million debut, sole-led by JP Morgan only days after Croatia's deal, was a great success. Although the borrower was rated the same as Croatia, BBB minus, Oman's issue was priced at 73bp over treasuries and, by mid-March, was still trading inside its launch spread at 70bp over.

The deal was well placed and supported in the after-market; spreads on most emerging market bonds widened over the same period after comments that Federal Reserve chairman Alan Greenspan made to Congress. He noted that emerging market spreads were too tight, and hinted at a rise in interest rates.

An official in Oman's treasury comments: "Our main concern is it does not go beyond 73bp over. There is no formal commitment from the lead but I'm sure, JP Morgan being a good institution and because Oman is a good name, it should perform well and be supported in the after-market."

The performance of the lead-manager in the weeks immediately following a deal is important. A first-time borrower's market profile is there to be created or destroyed by the inaugural deal's reception. A new sovereign issuer often has many goals. For example, the exercise may be designed to open the market for the country's corporates to issue in the international markets. A badly executed deal will fail to create the necessary goodwill.

Commenting on the deal in Euroweek, JP Morgan noted: "What helped this deal to defy the bearish mood in the market was the fact that it was placed with quality accounts who weren't interested in turning a quick buck, as happened in the Croatia deal." That was why it had not matched "the poor performance of the similarly rated Croatia deal".

In the cut-throat world of beauty parades, every lead-manager lives by its track-record. When Lithuania recently mandated JP Morgan to launch its forthcoming dollar Eurobond, some observers noted that the performance of Croatia must have counted against Merrill. As one banker puts it: "It's not difficult to show the Lithuanians a Bloomberg printout of Croatia's performance vis-à-vis Oman's. It's pretty black and white."

That the Croatia deal did not work is clear. But would it have worked better with just one lead-manager? When this question is put to Radovanic, he briefly chuckles. "Do I have to answer that question?" he asks, before adding, "No, I think it was a good strategy to have."

Not obvious partners

The history of the deal does not suggest the two houses were anxious to work together. Merrill muscled in on a deal that looked set to be a UBS mandate. The Swiss house could be forgiven for its confidence that it would win the lead-manager position ­ it had kept credit lines open during the war in the former Yugoslavia when everyone else closed the door. Early on, it received the nod to organize a Eurobond of probably $200 million.

But Merrill's relationship officer for Croatia, Pasquale Najadi, had different ideas. A former UBS man, he made clear he was hungry for this mandate. He even began pitching for the deal in the middle of the war. At one point in 1995 he spent two hours chatting with Croatia's finance minister, Bozo Prka, about opportunities in international capital markets.

After the peace treaty was signed in November 1995 his visits to Zagreb became more frequent. He knew the government needed funds for its post-war reconstruction programme and was equally aware his former firm UBS was readying a debut Eurobond.

Najadi advised finance minister Prka this would be ill-judged. Without a credit rating the Croatians would end up paying at least 250bp over treasuries. Najadi recommended a syndicated loan instead, and this was arranged by Dresdner Bank. This left UBS, which wanted to do an unrated Eurobond, defeated.

But Croatia could not afford to alienate its best European relationship bank. In January 1996, Najadi began to propose

cooperation. He met his former UBS boss, Croatian-speaking head of eastern Europe, Friedrich von Schwarzenberg. But UBS was not keen. However, in September the Croatian authorities mandated both firms as ratings advisers ­ a role which usually turns into a lead-management mandate. "I always told the Croatians I would love to work with UBS," says Najadi. "I didn't say, 'We are the best. We must work alone'."

There was also a political dimension. The Croatians believed that having an American bank's help might have a "significant impact" on how the rating agencies viewed Croatia. "We would like to tap all financial markets, and US investors are the most important in the world," says Radovanic, "although perhaps European ones are the most loyal."

The two leads were chosen for their US and European synergy, says Radovanic. But this argument ­ perhaps legitimate on a deal three or four times the size of Croatia's $300 million ­ only masks the Croatians' dilemma. In order to win the joint mandate, Merrill needed to convince the government that UBS was not capable of launching the deal alone, and that Croatia needed Merrill's greater expertise. By awarding joint books the government caused UBS to lose face.

Such manoeuvrings were unlikely to have UBS performing cartwheels to make the deal fly. Its track-record in Croatian securities, however, was good ­ particularly on the equities side. It led deals in 1996 for pharmaceuticals company Pliva (20 times oversubscribed) and Zagrebacka Banka (15 times oversubscribed). Moreover, it is no laggard in US distribution itself. Under former CSFB head of fixed income John Costas, its salesforce certainly knows the phone numbers of the top 50 US accounts. Had it been sole lead-manager the incentives to make sure the deal performed would have been strong. After all, UBS is Croatia's relationship bank and the deal was set to be its own first eastern European Eurobond.

This leads to the speculation: if UBS, and only UBS, had been accountable for the after-market performance of the bonds, would it not have given more effective support to the spread? As it was, the spread ended up rising almost 70% in the first month. The combined effects of UBS's balance sheet and its large Croatian credit lines would have allowed it to absorb a lot of paper if the responsibility for the deal's success had rested firmly in Zurich. But UBS had reason to feel this was not its deal.

Merrill, on the other hand, has a much bigger pipeline of emerging-market deals and, while nobody would accuse it of complacency, it is true that many of its other deals are higher on the New York syndicate's list of priorities than a $300 million issue for Croatia. So far in 1997 it has launched ­ among others ­ $1 billion deals for Colombia and Mexico and a $2 billion deal for Argentina.

Merrill's salesforce was widely criticized for selling too many bonds to so-called flipper accounts, which quickly traded out of them. One fund manager supports the view that Merrill was keener to get the paper off its books than distribute it as widely as possible. He recalls that he was offered $10 million of bonds by Merrill, but only $1 million by UBS.

"As soon as there was a whiff of panic, whoosh, out went the spread," recalls one investor. The leads say it got out as far as 127bp over, others say they saw it at 135bp over on inter-dealer brokers' screens. Comparable borrowers such as Hungary and Poland also widened during this period, but by only about 10bp to 20bp.

Market sources suspect Merrill found it hard to support the spread after Greenspan's remarks caused the sell-off of emerging-market bonds. As a result of its earlier jumbo Latin issues it was buying back a lot of paper in the market and taking a hit. Merrill disagrees with this interpretation. Repurchasing Latin paper, it says, would not have effected Croatia because that was done via New York's credit lines, while Croatia was managed from London.

David Tory, Merrill's head of European syndicate, blames market conditions for the deal's lack of success. "Anyone who wanted to take a directional view on spreads shorted the hell out of it," he says

Sabotaged deal

Tory argues that part of the problem with the deal was that it was sabotaged by two members of the syndicate which shorted it from day one. Having joint leads was not a problem. "Overall," he says, "the coordination between us and UBS was very good. As soon as the spread-widening occurred we were on the phone all the time."

"We've explained the situation to the Croatians all the way through," adds Tory. "They've been very disappointed with the market because the credit story of Croatia has not changed at all."

The bond was bid at 110bp over treasuries at the end of March, and Tory says the leads are nursing it back to its launch spread.

If Croatia's experience vis-à-vis Oman's offers any lessons for the first-time borrower, it might be that on small debut issues the borrower should commit to just one lead which it knows is accountable for its success. On deals of only $300 million the benefits of extra distribution do not outweigh the loss of accountability that comes with a joint-lead. In good markets this may not matter. But when markets turn rough that accountability is the borrower's security blanket.

The last time emerging markets were this choppy a similar incident occurred. South Africa returned to the international market for its first issue after the end of apartheid in December 1994 with a Eurobond that also had joint-leads, Goldman Sachs and SBC. The two lead-managers justified their existence by misguidedly persuading the borrower to increase the size of the deal by 50%. As a result the spread widened in a sceptical after-market from 193bp over US treasuries to 255bp over at Christmas and then was hit by the Mexican peso crisis. Within three months the debut was in tatters, trading at 360bp over. This is not a Eurobond that investors remember fondly. "We succumbed to the pressure of having a larger issue," admitted finance minister Chris Liebenberg after the event.

When the deal is a jumbo bond there is more justification for mandating two leads. When Russia launched its initial $1 billion bond in November it did so via JP Morgan and SBC Warburg. The two have a track record of cooperation in big deals, such as the debut dollar deal for Brazil in October and Mexico's $5.42 billion floating-rate note last July.

However, the forthcoming debut for Banco Sentral ng Pilipinas, the Philippines' central bank, is perhaps the most extraordinary jumbo mandate ever awarded. Not content with two lead-managers, the issuer appears to have appointed six. One banker has already christened it the "six-headed monster". The bond ­ a yankee, probably for $1 billion ­ will be launched in mid-April.

The mandated lead-managers are Salomon Brothers, Merrill Lynch, JP Morgan, Morgan Stanley, Citicorp and ING Barings. Quite what benefit the issuer hopes to gain from sticking four bulge-bracket firms alongside two commercial banks is unclear. More likely, the Philippines central bank views the bond as a means of repaying past favours. This is a particular problem in the Philippines which, in the course of its recent economic rejuvenation, has received quite a few favours. There are also many interconnected relationships.

For example, Citibank's point-person on the deal is Vaughn Montes, who has been at the bank for 11 years. He was hired by Teddy Montetillo, now head of the central bank's yankee bond committee. Citi's presence on the deal is largely a thank you for its help in power projects, and in setting up the country's Brady bond programme. At last year's Asian Development Bank annual meeting president Fidel Ramos gave Citi vice-chairman Bill Rhodes a medal for his contribution to the Philippine economy.

The other commercial bank in the group is ING Barings, which is the most active trader of Philippine debt. Its boss in Manila is Renato de Guzman ­ widely called Bing because his brother is called Bong. "Nobody can say 'no' to Bing," says a local rival.

Another favourite son is JP Morgan. It organized one of the deals of the year in 1996, the Philippines Brady exchange which raised $690 million. More practically, it has a good understanding of who buys Philippine debt, based on its work compiling the investor database for the debt exchange.

Then there is the intriguing role of local consultancies. Salomon was formerly adviser to the central bank on its credit rating, but this seems less important than its association with Buenaventura Filamor Echauz, a boutique with which Salomon agreed a link in 1995.

The Manila firm was established in 1991 when one of its senior partners, Eric Filamor, left Citibank. Filamor spent 25 years at Citi running its financial institutions group in Manila; one of his former protégés is Montetillo, the man running the inaugural bond issue. Filamor is one of the best-connected bankers in the Philippines.

Morgan Stanley has an agreement with newly formed consultancy, Lazaro Bernardo Tiv, which was set up at the end of last year. One of its founding partners, Romy Bernardo, used to be head of borrowing for the Philippines. He resigned from the department of finance after the successful completion of the Brady exchange last September.

These institutions, along with Merrill Lynch, made it through the beauty parade of 12 banks. Just after Chinese New Year the six were told to bring a decision-maker and a relationship-manager to a meeting at the central bank. They presumed this was for yet another elimination round.

At 4.30pm on February 10, the bankers were summoned en masse into a room with a table and 12 chairs. Each bank was allocated two chairs ­ a logistical problem for Morgan Stanley which had brought five people. The central bank governor, Gabriel Singson, told them the deal would be shared out among all six banks and that he would leave them for 30 minutes to sort out the arrangements among themselves. Then he walked out.

It was clear to all present that Salomon had the senior role because their guys had strolled in last, in step with the governor. But how senior the senior role was, was not clear. Salomon's Asia-Pacific chairman, Trevor Rowe ­ who doesn't have a syndicate background ­ agreed the deal would be done on the basis of joint economics. This was based largely on suggestions made by the central bank in a private meeting a little earlier. Joint economics means that all six firms would earn equal fees and be allocated an equal number of bonds.

When the New York syndicate heard that Rowe had agreed to this it was understandably perturbed. Such a position gives it little control of where the issue is placed, or how it will perform. The central bank listened to these concerns and re-cut the deal two days later. In a move that does not bode well for communications, Salomon asked the central bank to inform the other lead-managers.

The structure sees Salomon getting 25% of the bonds plus control of a pot comprising 40% of the bonds. It remains unclear whether the other five banks will carry the title "lead-manager" or not. Outsiders say this is merely a matter of semantics since the five will control too many bonds to be merely junior syndicate members; in the event of ego-driven friction they could gang up on Salomon.

Contacted by Euromoney, the borrower and the syndicate members say they are unable to comment on the unusual syndicate structure because of SEC regulations, which restrict discussion of a public issue before launch.

They're after a loan

Competitors find it an amusing spectacle. "They don't want to do a bond," says one banker, raising his eyes to the ceiling; "they want a loan instead." The danger is that the Philippines' reputation for professionalism, only recently acquired, will be put at risk by such an unconventional structure, especially if tough market conditions hit the performance of the deal, which is expected to comprise a 30-year and a 100-year tranche.

Bankers outside the syndicate know just how a debut emerging-market borrower ought to behave ­ and it's not how the Philippines central bank is behaving, they fear.

"The debut issuer is a black and white animal," says consultant Mooyaart. "In the white category is the issuer who trusts the bank that has been visiting him for years. He wants to do a successful issue and knows that capital markets are an expensive exercise anyway. Whether he pays 300bp, 310bp or 325bp over treasuries is neither here nor there. He wants the deal to fly and, when it does, he knows the second issue can be launched a little tighter. Continued success will lower his borrowing cost over the long term and give him access to different markets.

"In the black category is the issuer for whom friendly suppers will mean nothing. He just wants to force down the banks' bids. Then he says to the two that have bid closest, 'Why don't you think of joint lead-management?' Unfortunately that issuer is misunderstanding the long-term nature of the markets."

Yann Gindre, global head of debt capital markets at Commerzbank, says being matched with the tightest bid is unfortunate. But he says with a smile: "For the right client, would I ever be crazy enough to tell them I didn't want to work with the other house? No, because then I would lose the deal.