Wide gaps between initial price thoughts (IPTs) and re-offer spreads that have been a feature of recent benchmarks are rankling some investors, who argue the moves have in some cases been unnecessarily large and can leave them feeling foolish, although bankers defend the practice.

“After recent new issues, markets have revealed that – in contrast to previous thoughts – IPT in fact seems to mean ‘irrelevant pricing target’.”

So says Andreas Denger, senior portfolio manager and covered bond analyst at MEAG (pictured, centre), reflecting a view that is shared by others on the buyside.

“It is not easy to understand why initial price thoughts are at such wide levels,” he explains. “Not only investors but also other market participants acknowledge that, depending on the issuer and the country, IPT levels represent new issue premiums (NIPs) of 10bp-20bp.

“Given that no issuer is willing to provide too high a NIP, it is clear from the outset that the final pricing will not be within the IPTs.”

Denger – who is chairman of the ICMA Covered Bond Investor Council – notes that issues starting with NIPs of 15bp-20bp at the IPTs stage are likely to provide around 10bp at the final spread, while those starting with a NIP of around 10bp will end up with only around 5bp.

“This kind of NIP is fine, and investors clearly appreciate this,” he says. “However, when coordinating a deal among colleagues it is a mess to explain why the final pricing is far away from IPTs, sometimes even outside the spread range at book opening.

“A lot of investor trades are relative value-driven and a huge change in indicated issue levels kills off a lot of relative value.”

Denger also notes that not only are IPTs moving significantly, but issue sizes are often being significantly increased, affecting the bond’s potential performance.

“It is interesting as well that many issuers are both increasing the issue size and lowering the issue spread,” he says. “As an investor you can be left feeling like a fool. You are getting a bigger issue size for a higher price.

“Yes, a higher issue size may mean more liquidity and better allocation, which investors clearly like, but it also means less spread tightening potential, which in contrast is not liked very much by investors.”

One syndicate official agrees that some recent deals have seen spreads moving more aggressively than was usual, noting, for example, that the spread of a Bankinter Eu1bn seven year issue was tightened by 7bp from IPTs of the 30bp area to a final spread of 23bp.

“That is pretty aggressive, though they had an order book that warranted that sort of move,” he says “Speaking generally, I do see why some investors would be frustrated by how much the price sometimes moves during the process.

“But to be honest,” he adds, “this is nothing new.”

Syndicate officials argue that on the whole, recent price moves have been sensible, with many deals in the last three weeks having been tightened by 3bp-5bp during execution, which they say is in line with the moves seen before markets were closed during the height of the Greek crisis. Such moves, they argue, have been necessary in times of price discovery.

“In my opinion, it’s a bit of a percentage game,” says one. “If you’re a German issuer and you’re pricing at minus 10bp, for example, and then you tighten 5bp, that’s a big, big move.

“However, if you’re going from the low 20s to 17bp or 18bp, in this kind of environment – when there hasn’t been supply for some time – that is appropriate. There is a price discovery process.”

In times when execution risk is elevated as it has been recently, say syndicate officials, it makes sense for lead managers to launch a deal with cautious IPTs.

Denger, however, disputes this, noting that recent deals were well supported, and that central banks participated strongly in most new issues, as expected.

“Books are all well oversubscribed,” he says. “Therefore fear of a deal not working is currently not such a good excuse.”

Syndicate officials also cite the impact of the European Central Bank’s covered bond purchase programme as making it more difficult to establish appropriate IPTs.

“Nowadays you can’t soft sound people and work with investors before you put a deal on screens, so you’re blind in many cases,” says one. “You’ve seen the ECB taking out a significant chunk of the secondary markets, and that means that liquidity is drying up as well.

“That means finding out exactly where people care for a deal, without speaking to them and without seeing significant secondary flows, is proving exceptionally difficult.”

He adds that spread moves in any future deals going into the summer would likely be smaller, as syndicate officials can refer to comparable deals from recent weeks and launch new issues with more certainty regarding price.

Furthermore, some syndicate officials say that investors who are unhappy with price moves should limit their orders or drop out of a deal, in order to provide the leads with a better picture of their expectations.

“I don’t think any investor can complain, because secondaries are distorted by the ECB, so we have to guide ourselves with investor feedback,” says one. “And if investors don’t give you feedback that is defined, then as a syndicate you have to plug in all the different angles of relative value to decide where fair value is.

“Assuming the NIP has to be 5bp-10bp, you end up at 5bp. That is bound to happen and I don’t think anyone can complain.”

Denger agrees that secondary market curves are affected by central bank purchases, but argues that on the other hand issuers regularly provide investors with a range of ] comparables to indicate where their newly-issued covered bond should be priced.

“And – surprise, surprise – the final spread mainly fits within the provided ‘comps’,” he says. “So even though secondary market curves are distorted, there still seems to be a good indicated price out in the market.”

The syndicate official meanwhile notes that pricing moves in US dollar trades are not so pronounced, as the US market has a smaller investor base where investors more often put in orders at a set price.

Another syndicate official agrees that it has been difficult to know how investors feel about the pricing process when most follow spread moves down.

“It’s a self-fulfilling prophecy,” he says. “If investors are following the moves down, you don’t really know, then obviously you still have this ever increasing order book to leverage the price further.

“It’s very rare now that you get an investor who has a limit at which they’ll drop the order the second you go through it. When the market is good people don’t really tend to drop orders that much.”

Denger agrees that it would be welcome if investors would include a spread limit with their orders.

“But, to be honest, most investors just got tired of lowering and lowering the target because the spread gets tighter and tighter and they need to invest,” he adds. “Sure, syndicates can say that at the end investors can be happy to still get a NIP and due to increased book size a good allocation.

“However, it is about how we get to there. The result is fine, it’s just that the road is very bumpy.”

Denger says he doubts that IPTs are still required to successfully place a covered bond issue, suggesting instead that syndicates could set a fixed spread range from the beginning.

“Is a good deal or even a deal of the year the one that manages a high spread tightening from IPT to final price and has a huge oversubscribed book?” he asks, “Or is a good deal a deal where guidance was well set close to the pricing level, where size was well chosen, and the bond showed a good secondary market performance not only a few days after issuance?”

“And what is a good syndicate? The one that enables tight pricing after irrelevant IPTs together with a huge book, where at least some interest came due to the high IPTs, and taking into account less happy investors? Or is a good syndicate one that can set a fixed spread range investors can rely on while the issuer is still happy?”

“Such a deal leaves a much more friendly relationship between issuers and investors. This should pay off when meetings are up or new issues are planned.”