Merrill seizes chance for long-term benefits

When the US Treasury re-opened the 30-year dollar bond market in February, it prompted the question of who would be next to do so. Merrill Lynch was determined that the answer would be the European Investment Bank – and so it proved, within a fortnight, with EIB’s first $1bn 30-year bond.

Long-term bond issuance has been growing in euro and sterling as European and UK pension funds strive to match their assets more closely to their liabilities. But long dollar bonds have been conspicuous by their absence since the US Treasury stopped issuing them in 2001.

Fine tuning to be done

US pension fund managers now face the prospect of reforms that will require them to fine tune their assets and liabilities in the same way as their transatlantic cousins. So their appetite for longer-dated paper has been similarly sharpened, and last year the Treasury indicated that it would oblige with a new 30-year issue.

The opportunity that this might present was not lost on EIB, which promptly began to contemplate the possibilities. As it says, it has a natural desire to issue benchmarks along the curve, wherever there is demand.

Merrill Lynch had acted for EIB in the past but had not led a dollar issue for the bank for nearly six years. Without a US Treasury benchmark, it would have been difficult for a supranational to price a 30-year dollar deal fairly. But once it became clear that the Treasury was going to resume issuance in that maturity, Merrill Lynch began to argue the case for EIB being first out of the gate, and to put forward its credentials for participating in the transaction.

“An organisation like EIB is very stringent about eligibility criteria,” says Amir Hoveyda, Merrill Lynch’s London-based head of Europe, Middle East and Africa debt capital markets. “You have to check a lot of boxes. We have a significant presence in the dollar space and, among other considerations, we have been seeing to their needs on the structured notes front – which is very important.”

EIB is the world’s largest non-domestic dollar issuer, so it made sense for it to lead the charge (though Germany’s KfW might also have been a credible contender). “Very few issuers in the world could have done this deal,” points out Paul Richards, Merrill’s head of European fixed income syndicate. “But EIB is very large, with a global footprint and a reputation as a market leader in innovation and boldness.”

Given that all went well with the US government transaction, Merrill firmly believed that EIB could do a benchmark-sized deal so it focused very aggressively on proving its case.

“Other names would like to have done this first: US agencies, EIB’s peers,” says Stuart McGregor, head of Merrill’s frequent borrowers group for sovereign and supranational credits. “We felt strongly that EIB was the right name, and it felt strongly that it wanted to be first – if market conditions were right.”

Awaiting crucial outcome

Indeed, there is little point in being first to do something if you make a mess of it. So the outcome of the Treasury issue was crucial, and it was not a foregone conclusion that the Treasury would get it away without problems. Would the pricing prove too expensive, as some in the market feared, so forcing yields higher? “We were all waiting to see how the auction would go,” Mr Hoveyda recalls.

It turned out to be the capital markets equivalent of the latest Harry Potter book: end investors fell over themselves to get their hands on the paper directly. The $14bn issue was more than twice oversubscribed and the yield ended up significantly lower than that on the shorter-dated outstanding 30-year.

“That’s a very unusual circumstance on a positive-sloped yield curve,” Mr Richards says. “The people who participated in that auction were very hungry for long-end assets, and particularly for on-the-run [latest benchmark] long-end assets.”

At this point the team stepped up its efforts to demonstrate its confidence and competence to EIB. “Because of our constant dialogue with the end-investor base, we were able to go out and build a shadow book,” says Mr Hoveyda. “Such a transaction would be a big step for EIB. This was a space where they hadn’t been before, and with a firm that they hadn’t yet tested in this currency for a long time. But the shadow book substantiated our story and gave EIB confidence. We were able to show them who would be their potential audience.”

Less than two weeks after the Treasury auction, on 21 February, EIB awarded Merrill Lynch and joint lead JPMorgan a mandate for a 30-year benchmark dollar issue. The trade was announced the same day. “Usually, there would have been more pre-marketing,” Mr McGregor acknowledges, “but given the feedback we had, EIB felt confident enough to move directly into the marketplace.”

EIB typically spends four weeks a year marketing in the US. It had issued $2bn in 10-year paper three weeks earlier and this would be its third benchmark deal of the year. “It is very active in that market, so there was no question that investors might say ‘no’ because of the name,” Mr McGregor says.

The challenge for the lead managers was how to maximise US demand – which is typically less hungry for European names – while cultivating European appetite. While European pension funds are increasingly drawn to longer-dated paper, they need a little extra encouragement to buy dollar-denominated assets.

The bookrunners were sure that they could appeal to both sides of the water but, even so, the outcome took everyone by surprise. “We originally expected orders to be more heavily skewed to US investors,” Mr Richards admits. “But it became clear early on that there was significant demand in the European market. It’s not that we were underwhelmed by US demand, but we were overwhelmed by Europe.

Dollar buyers

Having been negative on the dollar for some time, European investors have been reversing that bias in their portfolios for the past six months or so, becoming dollar buyers. EIB was a beneficiary of that trend, even as it prospered from domestic US pension funds’ increasing interest in the long end of the market. The bank wanted a liquid benchmark, and all concerned agreed that $1bn would be the right size. It has a triple-A rating from the three main rating agencies. Pricing for the issue began at low-to-mid 40s basis points over the recent US Treasury 4.5% 30-year bond and was finalised at 43bp. The coupon was 4.875%.

The distribution figures made compelling reading, with 49% going to Europe, 48% to the US and a mere 3% to Asia. The paper-thin Asian demand was understandable since, in this market, it is normally driven by central banks, who have little interest in extended maturities. Only 3% of demand came from central banks, while non-banking institutions took 74%, with banks accounting for 23%.

The transaction drew $1.5bn in orders from about 60 investors. “You would be pleased with that number of accounts in a five-year offering,” Mr McGregor says. “The breadth of distribution shows that we were facing a structural change, a real need for long duration assets, not just a one-off pocket of demand.”

He is almost certainly right, and we can expect to see other high-grade credits queueing up to tap the long dollar market. As Mr Hoveyda says: “This was not just a flash in the pan. It’s here to stay.”