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Pricing bonds

25 April 2018
Richard Kemmish

Arguments between syndicate desks and investors are nothing new. But they are about to get a lot more important. Can anything be done differently?

Investors constantly complain about overly-generous new issue premia evaporating as soon as a deal is seen to go well. They give away information about demand to syndicate desks only to have that information used against them to reduce the ‘consumer surplus’ – the difference between the price they have to pay for the bond and what they would be willing to pay for it. Then to make it worse they get a ‘negative convexity’ of allocations – poor allocations if the deal goes well, high allocations if it’s a dog.

I have a lot of sympathy for the syndicate desks (as an ex-DCM person I find it difficult to type those words). Pricing a new issue is more difficult than ever with poor secondary trading, a fundamental mismatch between supply and demand and the market abuse regulations making meaningful market sounding next to impossible.

But whilst this has been an argument over the odd basis point until now it could be about to get a lot more serious.
Perceptions and press comments about failed deals are mildly annoying for good banks in a benign funding environment but potentially catastrophic for banks flirting with a ‘failing or likely to fail’ ruling from the ECB, or in a crowded new issue market where it could be months before your next issue window.

In the worst days of the crisis the Initial Price Talk on a deal was overly generous to ensure that it actually got done. The downside was too great – a failed funding deal mid-crisis could be catastrophic – if only for signalling reasons. A few too many basis points in comparison was a mild inconvenience.

But now that we are inured to large IPTs, their purpose has changed. Syndicate desks now use them to address the vast uncertainty in fair value. With the supply / demand balance of power what it is there is little downside for the issuer in cutting the new issue premium from that which was implied by the first pricing talk. Grumpy investor? Who cares? Plenty more where they came from.

As a result of this an expectation of heavy over-subscriptions has become the norm. At least in the press: you fail if you aren’t oversubscribed. That orders are rarely price limited guarantees heavy over-subscriptions when IPTs are wide.

It has always struck me that if were to put all capital markets on a continuum from Hi-tech IPO to German agency then there is a fairly clear correlation between the quality of the issuer and the over-subscription level that gets described in the press as a success. We need to reboot expectations. 1.1 times covered is a good result for a rates product.

More price limited orders, allocations that better reflect the quality of the order (sorry ECB, but coming in when the book is closing gets you sent to the back of the queue), and clearer communication (rather than stating one number for an indicative level, quote two: our estimate of fair value and the new issue premium we are proposing) would all help.

As the balance of power between investors and issuers changes, so must behaviour.


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