Thursday, April 21, 2016

Banks get higher fees in bond deal

The JP Morgan headquarters in New York City as seen in a file photo.

By Ignacio Portes
Herald Staff

Debt issued at rates below market value ensures rapid profits for banks involved

Argentina has effectively paid banks much higher fees than publicly stated as part of its massive debt issuance, as the bonds it sold immediately soared in value on secondary markets, where investors can freely re-sell them, giving initial holders rapid gains.

That means that the country likely sold the bonds at a price below their market value, ensuring the banks that initially received those bonds an immediate, risk-less profit which, in practice, works as a second commission.

Traders consulted by the Herald said the move is a common — although not entirely transparent — way of ensuring that both the banks that organize the transaction and the investors that directly buy Argentina’s bonds make money out of their loan, keeping them happy for the next time the government needs to ask them for money.

The contract for the bonds sold by Argentina on Tuesday says that the banks take a commission of 0.18 percent of the funds they manage to raise for the country, a fee relatively in line with the 0.16 percent average paid by across Latin America this year.

With the bond sale totalling US$16.5 billion, that 0.18 percent fee would mean that banks take US$29.7 million in commissions for the transaction.

But in practice, the banks secured much higher gains than that on Tuesday, as the value of the Argentine bonds soared on the so-called “grey market” before they became available for trade.

“The bonds already rallied in the grey market, with three percent gains for the 30-year, two percent for the 10-year, 1.5 percent for the 5-year, and around one percent for the 3-year bonds,” a report from the Puente brokerage said yesterday.

That, according to experts contacted by the Herald, is a sign that the country had more room to negotiate a cheaper interest rate had it desired to do so, but that it decided against it in order to secure extra gains for the banks, which could then immediately re-sell them to their clients at a higher price.

The difference between the bonds’ official price and their initial trading price could mean that the banks end up imbursing an additional fee several times bigger than the formal US$29.7 billion commission that the contract entitles them to.

Luring banks

The soaring price of Argentine bonds immediately raised some eyebrows among local economists.

“Is this good, or does it mean we paid too much?,” Carlos Rodríguez from the CEMA thinktank postedon his Twitter account.

In financial circles, some also complained that, as Argentina was offered four times the amount of loans it wanted to take, the country could choose who to reject, and minority investors suffered more rejections than the banks. That ensured that, when those investors moved to buy the bonds on the secondary market, they would have to pay a higher price, securing the gains for the bankers.

But while those investors complained, other fund managers argue that pricing bonds below their expected market value is a normal move, designed to keep banks and direct buyers happy, as the country will need them on future bond sales.

“It is typical in sovereign bond sales and on companies’ initial public offerings. It is a way of securing that investors are tempted. If the banks know there’s some juice to take out of the operation, they are more likely to participate in it,” Rafael di Giorno from Proficio investment told the Herald.

In his view, the fact that Argentina was offered US$68 billion and only sold US$16.5 billion means that there was clearly room to negotiate a lower interest rate than the average 7.14 percent that the country obtained.

“If you don’t negotiate a lower interest rate, then the rates will immediately go down as soon as the bonds begin to be traded in the market. But you need that incenctive to ensure that investors offer money for your bonds. Without those gains, everyone would wait for the bonds to come out in the secondary market and you would get less offers,” Di Giorno argued.

Common, yet not

fully transparent

According to a US-based trader, the move is standard practice among banks to make fees bigger than stated.

“That is how banks make their money. It’s silly, but not uncommon. Some day, in the name of pure transparency and considering the fact that (the fee and the difference between the official price and the market price) are interchangable, that practice will go away,” the trader told the Herald.

Banks, in his view, could simply charge a higher fee and do away with the risk-less grey market profits.

For now, however, the practice is expected to continue. Argentina is unlikely to pay a fee above the region’s average, as it wouldn’t look good politically, and it is also unlikely to press banks and investors for the absolutely lowest rate possible.

“Argentina could have got half a point less in interest rates, but in this way you secure that these banks and investment funds will be back next year for the next bond issue,” Di Giorno said.

@ignacioportes