Spain’s structural reforms are paying off, with bonds from the non-core EU country – led by the Madrid region – attracting buyers from around Europe, as Edward Russell-Walling reports.

Barclays team of the month 1116

Which peripheral eurozone paper is most favoured by bond investors? Spain is a frontrunner, if Madrid’s recent issue is anything to go by, pricing inside similar bonds from the republic of Italy. One of the deal’s bookrunners was leading sovereign, supranational and agency (SSA) house Barclays, a familiar name on public sector issues from Spain.

Most non-core eurozone members have cleaned up their act since the eurozone crisis, but Spain has probably done more than most. “Spain has achieved a huge amount by way of structural reform, in areas such as labour markets, pensions and the banking sector,” says Lee Cumbes, Barclays’ head of public sector, Europe, the Middle East and Africa (EMEA). “It had a plan and it stuck to it, and is now trading well through peripheral peers.”

Yields on Spanish public sector debt shot north of 6% (for 10-year bonds) during the eurozone crisis. Since European Central Bank president Mario Draghi steadied the ship with his 2012 promise to do “whatever it takes” to save the euro, they have gradually settled back to 1% and below.

Political issues

Earlier in the year, comparative yields had put Italy ahead in the popularity stakes. That was partly thanks to heightened Spanish political risk. The country has been without a government since last December’s election ended in a hung parliament. A second vote in June yielded a similar result, as socialist leader Pedro Sanchez continued to block conservative Mariano Rajoy’s attempts to form a government.

If this impasse is not broken, Spain faces a third election in December, the prospect of which does not amuse Spanish voters. However, hopes for a resolution have been rising, particularly since internal party opposition prompted Mr Sanchez’s recent resignation.

While Spanish fortunes have brightened, Italy’s immediate future now seems less certain. Prime minister Matteo Renzi has staked his personal political future on a positive result to December’s upcoming referendum on constitutional reform. This is a gamble he may be less likely to win than he once thought, and his departure would only heighten political and economic uncertainties in Italy, where the banking sector has been struggling under a mountain of bad debts.

Meanwhile, back in Spain, the autonomous community of Madrid is one of the country's healthier regions. Many were able to fund themselves independently before the financial crisis. After it, the weaker regions lost individual market access and were obliged to rely on government financial support via the liquidity fund for the autonomous communities. Madrid was not one of these overleveraged regions.

“Madrid was always one of the stronger regions in the eyes of the market and it never lost market access when there were difficulties for others,” says Mr Cumbes. “It has always been market-savvy, with a professional team, and has been keen to retain financial independence.”

Madrid has to time its visits to the bond market carefully, taking into account constraints such as government approvals and the flow of tax receipts. It had already issued once before in 2016, in May, when it sold a €700m five-year bond with a coupon of 0.727%. That represented a spread of 27 basis points (bps) over comparable Spanish government bonds (SPGB).

Local demand

Given the distribution of the subsequent issue, it is worth noting who bought this first bond of the year. Most demand came from Spanish investors, who took 65% of the total. The next most important geographic market was Germany and Austria combined, which took 13%. Fund managers accounted for 34%, banks 30% and insurance and pension funds 29%.

Madrid came back with its second 2016 transaction in the third week of September, with Bankia, Barclays, BBVA, Santander GBM and Société Générale CIB as bookrunners. While markets had been volatile, the deal was launched in more constructive conditions. 

“Madrid struck the market at a great time,” says Mr Cumbes. “We had gone through the summer with a feeling of peak quantitative easing [QE] stimulus in Europe and Japan. We were starting to hear investors say this was the low for rates and that maybe governments would look more to fiscal stimulus as an alternative to monetary means. Supply was coming back after the summer and we thought it was sensible to get into the market.”

The new transaction was a €500m eight-year benchmark bond, with initial price thoughts in the interpolated SGBP plus low 30bps area, which implied a 1% coupon. Yumi Yang, Barclays’ head of SSA syndicate EMEA, notes that as investors have increasingly been looking for spread and yield over the past year or two, they and issuers have both become more flexible around tenors in order to meet their targets.

She acknowledges the eight-year tenor reflects this, adding that those who now buy eight-year paper are often more used to buying shorter maturities.

“The eight-year tenor fitted Madrid’s needs,” says Ms Yang. “And when we started marketing, the psychological attraction of a 1% coupon gave the book strong momentum. This was an opportunity for a pick-up versus Spain, interpolating the curve.”

Political demand

With very low core eurozone yields, there is increasing demand for peripherals and, since Madrid is effectively a sovereign risk, any spread is an added bonus. With revised price guidance at interpolated SGBP plus 28bps area, the response from investors was sufficiently enthusiastic to generate indications of interest worth more than €1bn. When the final spread was set at 26bps, with a 0.997% coupon, the order book grew to €1.1bn, though the deal size stayed at €500m.

This time, Iberian distribution represented only 38% of the total, with 20% going to Austria and Germany, 14% to Italy, 12% to France and most of the rest to the Benelux countries (8%), Switzerland (5%) and the UK (2%). There was a higher proportion of real money investors, with fund managers taking 43%, insurers and pension funds 28% and banks 25%.

“There were still a lot of Spanish buyers – people buy what they know,” says Ms Yang. “But what was very positive for Madrid was that over half of the bonds went to other European jurisdictions. It’s good to diversify your buyers, and this transaction reflects the work Madrid has done to position itself with key investors.”

Longer dated bonds

Mr Cumbes says the sell-off in peripheral public sector paper initiated by the eurozone crisis took some time to settle, and that current market conditions reflect fundamentals, not just technicals of supply and demand. He notes there is more appetite on the part of issuers, who are responding to investor concerns over ever-lower yields with longer dated bonds.

Barclays was a bookrunner and duration manager on the kingdom of Spain’s first ever 50-year syndicated bond, launched back in May. Kicking off with price thoughts of mid-swaps plus mid-to-high 250s, this generated indications of interest of more than €6.5bn. The order book eventually grew to more than €10.5bn, allowing the size to be set at €3bn, priced at mid-swaps plus 250bps with a 3.45% coupon.

UK and Irish investors, with their taste for longer dated bonds, were better represented here, taking 22.6% of the transaction, followed by Spain (16.7%) and the US and Canada (16.4%).

Italy recently joined the half-century club with its own 50-year bond, overtaking Spain once again. It attracted €18.5bn of orders for a €5bn deal yielding just 2.8%. Barclays was not involved, though it was a bookrunner on Italy’s first new 20-year government bond, launched in April. This pulled in comparable orders of €18.9bn for a deal sized at €6.5bn with a 2.25% coupon.

Mr Cumbes expects more of the same, though perhaps not immediately. “In Europe, with the ongoing QE programme, there is the possibility that rates could go even lower,” he says. “The market is looking for longer dated assets to get yield, and issuers will likely be keen to offer new opportunities again into 2017.”

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