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WorldSeptember 1 2017

Capital market buoyancy helps drive Spanish recovery

With consumer confidence on the rise, unemployment at an eight-year low and investor perceptions changing for the better, Spain appears to be emerging from the economic doldrums. David Wigan reports on the forces driving the recovery and finds that – despite some reasons for caution – it appears to be gathering momentum.      
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Spain pay

In the land of festivals, the sun is shining. Spain is the eurozone’s fastest growing economy, driven by a recovering housing market, booming tourism and a rebound in consumer confidence that signals an eight-year economic slowdown is at last over.

The country's gross domestic product (GDP) will likely expand by 3.2% in 2017, according to economists’ estimates, and in June the number of registered unemployed fell to the lowest level since February 2009. Construction, which played a central role in the country’s financial crises, is growing strongly, with job creation reaching 6.3% in the second quarter and 120,000 new houses expected to be built in 2017, more than double the number seen three years ago.

“If anything, the optimistic opinions expressed in respect of the Spanish economy earlier this year were not optimistic enough,” says Antonio Garcia Pascual, chief economist for Europe at Barclays. “We expect growth to hit 3.2% for a third consecutive year, supported by a banking sector that's firing on all cylinders and which has allowed Spain to recover faster than its peers.” 

Orchestrators of the recovery

A key player in Spain’s recovery has been the European Central Bank (ECB), whose monetary policy and quantitative easing programmes have kept interest rates low, according to Mr Pascual. Banks have accessed about €173bn of cheap funding through the ECB’s lending schemes, and Spain’s mortgage market is closely linked to the 12-month Euribor rate, which was -0.15% in early August. That has pushed down mortgage costs and provided consumers with more disposable income.

The Spanish government has also played a role, forcing banks to increase provisioning and transparency, promoting mergers between cajas (saving banks) and setting up Sareb, the bad bank to which non-performing real estate assets of banks were transferred. Those efforts were supported by EU financial assistance programmes that injected €38.9bn for bank recapitalisation and about €2.5bn for Sareb.

In supporting the banking sector, the Spanish government appears to have also done itself a favour, because as banks have regained their footing, sovereign borrowing costs have fallen sharply. Spanish 10-year yields were at 1.63% in July 2017, compared with 6.7% five years ago. The government now pays about 1% more than Germany for long-term money.

Bonds boom

Not surprisingly, as the cost of borrowing has dropped, the Spanish government has taken advantage, and first-half 2017 sales of sovereign debt were the highest since 2014, with the Treasury selling more than €34bn of bonds, including four syndicated placements amounting to €27bn. One €8bn trade in July attracted nearly €30bn of orders.

“There was a period during the financial crisis when for certain sovereigns it was difficult and expensive to issue debt. Now there is huge investor demand and they can sell bonds without a problem,” says Eloy Fontecha, global head of fixed income at Spanish lender BBVA. “The regions are also coming back to the private and public markets after facing even bigger difficulties. They are offering standard senior debt and also new formats such as green and social bonds.”

The first green bond was sold by the European Investment Bank in 2007, with proceeds assigned to renewable energy and energy efficiency projects. Ten years later the asset class has passed €100bn of outstandings, and Spanish entities have been among the most enthusiastic issuers. Earlier in 2017, the Comunidad de Madrid became the first Spanish public administration to sell a sustainable bond (a blend of green and social bonds). It attracted €1.4bn of orders in just three hours for the five-year security and ended up selling €700m.

“Investors are incredibly supportive of green bonds and we are seeing issuers across the corporate, financial and public sectors respond to that,” says Mr Fontecha. “We set up a specific team to focus on green issuance three years ago, and now a lot of institutions are interested.” 

Among recent deals, in July BBVA worked with ADIF Alta Velocidad, the high-speed rail infrastructure manager, to sell €600m of six-year bonds to finance new infrastructure. Earlier in 2017, the bank structured a green bond for oil and gas company Repsol, the first green security to come out of that sector. The deal raised eyebrows in some quarters over a possibly stretched definition of the 'green' asset class, but in response Repsol published plans for spending the €500m of proceeds on energy efficiency.

Financial bonanza

While the government and related entities have been the biggest issuers in Spain in 2017, the newly recalibrated financial sector has run them close, with banks continuing to rebuild their balance sheets. Spanish banks sold €29.9bn of debt in the year to July 27, compared with €14.6bn the same period in 2016, according to data provider Dealogic.

A key driver has been a change in the law designed to help banks meet their regulatory obligations to stock up on loss-absorbing capital, which can be used to cushion losses in the event of a bank resolution. A royal decree in June made it legal under Spanish law to issue senior non-preferred debt, a new type of asset class that debuted in France in 2016 and which is eligible for bail-in under Europe’s Bank Recovery and Resolution Directive.

Senior unsecured non-preferred instruments, known oxymoronically as 'junior senior' debt, will rank lower than senior debt and senior to subordinated claims in capital structures. The bonds are eligible as capital under the Financial Stability Board’s (FSB's) standards for the total loss-absorbing capacity (TLAC) of systemically important banks, or as minimum own funds and eligible liabilities (MREL) for the rest.

While the new law rubber stamped senior-non preferred securities, bank issuance was in fact already under way.  Santander faces a January 1, 2019 deadline to raise as much as €26bn of TLAC and realised late in 2016 that it needed to act quickly to reach its target in time. With that in mind, at the end of January the bank launched €1.5bn of five-year 'second ranking senior' notes, attracting just over €4bn of demand. It followed up with a $2.5bn three-tranche deal in April. The bonds were rated Baa2/BBB+, compared with the issuer’s A3/A rating, and the notes contained provisions for automatic alignment of their terms and conditions to future statute once the law was adopted.

The FSB has calibrated final TLAC standards for systemically important banks, but most Spanish institutions (comprising all but Santander) are waiting for detailed guidance on the quantum of MREL requirements as a proportion of risk-weighted assets, which is expected to come before the end of September.

In terms of total debt issuance volumes, BBVA and Santander have been the most active banks, but the market has also seen the return of a slew of smaller lenders, including Bankia (formed in 2010 after the consolidation of seven cajas and partially nationalised after nearly collapsing in 2012), CaixaBank and Banco Sabadell.

Signs of recovery

One sign of the strength of the Spanish capital markets is the fact that bank subordinated debt has continued to perform well in secondary trading, despite events surrounding Banco Popular, which failed in early June. The bank was the latest and, hopefully, last victim of the real estate bust and was dealt its final blow by customer withdrawals that saw it burn through €3.6bn of central bank emergency liquidity in a little under two days. It was saved from insolvency when European authorities arranged for its sale to Santander for €1.

One notable aspect of the deal from a bondholder point of view was that as part of the Popular deal there was a total write off of Popular’s (deeply subordinated) additional Tier 1 (AT1) debt and its (subordinated) Tier 2 bonds. That was a blow for investors because Tier 2 was not protected as they might have expected.

“We saw the spread between AT1 and lower Tier 2 tighten, because of the view investors took about being equally penalised in an adverse scenario,” says Nacho Moreno, Barclays co-head of banking in Spain. “However, just a few weeks later we saw CaixaBank issue a Tier 2 security very successfully.”

The day before the Caixa Tier 2 deal, Bankia was also in the market, selling its inaugural AT1 and the first Spanish AT1 since the Banco Popular episode. Bankia attracted €3.5bn of demand for the perpetual non-call five-year bond, which paid investors a return of 6%, the lowest ever coupon for a Spanish AT1.

Reasons for caution

The successful Caixa and Bankia deals show that investors have moved away from treating Spanish credit as a single asset class to take a more nuanced view, bankers say. However, that does not mean the sector is entirely in the clear and the banking system is still weighed down by significant levels of non-performing loans.

"The peak for non-performing assets was about €380bn and that has fallen to about €280bn, which is equivalent to about 25% of Spain’s GDP, so while exposure has reduced significantly it is not exactly immaterial,” says Marta Sanchez Romero, a financial equities research analyst at Bank of America Merrill Lynch. “The bad bank has €40bn of assets in net terms (compared with €50.8bn when it was set up) and the sector has received significant injections of capital from Europe, most of which went to Bankia.”

Given the progress they have made, banks have recently returned to higher levels of lending, mainly to fund corporate cash flows, according to Ms Sanchez Romero, but the loan portfolio is still shrinking and banks continue to own €81bn of Spanish real estate in a market that is trading 30% below where it was 10 years ago.

Corporates tune in

Spain’s corporate lending landscape was dominated until recent years by traditional bank loan activity, with about 70% of corporate funding coming straight from banks. However, as financial institution balance sheets contracted during the recession, capital markets started to come into their own. Large companies in particular have taken the opportunity and banks estimate Spain’s corporate giants now access public markets for about two-thirds of their funding needs.

The standout transaction in recent months came from Spanish multinational telecommunications provider Telefonica, which in March sold $3.5bn of 10-year and 30-year paper to US investors, marking the company’s first foray into the dollar market since the financial crisis.

“The Telefonica deal showed that globally there is demand for names from Spain, and it worked for the company because it’s a lot easier to do 30-year funding in dollars than in euros,” says Jean-Marc Mercier, global co-head of debt capital markets at HSBC. “It’s a sign that Spanish capital markets are returning to the international fold."

New-found confidence

Spanish corporates had sold €17.7bn of debt by early August 2017, compared with €14bn in the same period in 2016. Issuance is the highest since 2014, with there being €19.9bn of issuance by early August. Higher demand in 2014 likely reflected reduced bank participation in the loan market.

One thing that has marked corporate issuance in 2017 is the high level of new issuers. One to have caught the eye is FCC Aqualia, a subsidiary of infrastructure and service company FCC Group, which sold a hefty €1.35bn of bonds due in 2020 and 2027 to enable its parent to amortise €1.1bn of existing financing.

“This was a dual-tranche transaction executed on a secured basis and it was structured in such a way that the parent was able to assign a portfolio of its debt to the subsidiary, which is a high cash-flow company," says David Fernando García, co-head of debt capital market at Société Générale in Spain, which was global coordinator on the deal. “By securing the transaction we were able to get an investment grade rating and the outcome was extremely positive.”

UK investors in particular were big buyers of the FCC Aqualia deal, and the €3bn order book suggested international buyers are not afraid to take on more complex structured transactions issued by relatively unknown Spanish companies.

“Spanish companies generally can rely on local investors to take about 20% of any deal, but for the rest they need to go elsewhere in Europe,” says HSBC’s Mr Mercier. “I don’t have anyone today saying 'I am not buying because it’s Spain'. The zip code is not a problem."

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