Spain shrugs off Italy turmoil with 10-year benchmark

Pablo de Ramón-Laca

Five years of current account surplus, a declining fiscal deficit and 18 straight quarters of economic growth: Spain’s turnaround since the 2012 sovereign debt crisis and bailout is something of a fairy tale. Its economy is one of the best performing in Europe, driven by soaring exports, rising investment and the lowest level of unemployment (in the second quarter of 2018) for 10 years.

Little wonder then that investors are keen on the Iberian country's debt. The yield on Spanish 10-year bonds was 1.36% in recent trade. This compares to a record 7% six years ago, which was just after the country announced it would borrow up to €100bn to support its banking sector. The last time Spain sold a 10-year bond, in January, the order book reached €43bn, the second biggest in eurozone history.

Political concerns

Of course, market sentiment can quickly shift. When the sovereign considered selling another 10-year benchmark in May, the mood music had changed, with Italian bond yields rising sharply amid concern over political turbulence in the country. But given its commitment to maintaining its curve and its redemption requirements, Spain was never going to walk away. This year’s net funding needs are €40bn, about one-third of what they were nine years ago, but gross needs are in line with 2009 levels (about €215bn) while redemptions amount to €86.3bn.

“The timing of our second 10-year benchmark of the year was key,” says Pablo de Ramón-Laca, head of funding and debt management at the Spanish Treasury. “The summer break was approaching and we had had moments of unusual secondary market volatility related to the Italian political situation. We had also had a change of government in Spain, which, I must say, the market took completely in its stride, with minimal disruption.”

In addition, borrowing conditions have been improving. Spain’s average cost of new issuance has fallen from 4.2% just before the sovereign debt crisis to about 0.75% in recent months. The average cost of the country’s entire debt stock, including new securities and live debt, has fallen from 4.53% at the end of 2007 to the current 2.5%. Meanwhile, the country has extended the average life of its near trillion-euro debt portfolio from 6.2 years in 2013 to almost 7.5 years today, positioning itself for the inevitable rise in central bank rates, which will have a larger impact on the short end of the yield curve.

In deciding when to sell bonds and in what quantities, Mr de Ramón-Laca notes the Treasury must assess several factors and “strike the right balance between predictability and flexibility”. On the one hand, its mandate is to cover the central government’s cash needs at the least cost to Spanish taxpayers. “So we need to be alert to issuance opportunities by keeping a close eye on market dynamics,” he says. “On the other hand, Spanish sovereign bonds are Spain’s risk-free asset, against which most other Spanish fixed-income instruments are priced, so we have a responsibility to be as liquid and as predictable as possible.”

No-nonsense approach

When it comes to structuring deals, the Treasury takes a no-nonsense approach, aiming for simplicity and consistency. “We want our product to be standardised, liquid, and therefore as plain vanilla as possible, so as to qualify for the large fixed-income indices,” says Mr de Ramón-Laca. “So for the most part, we issue liquid zero-coupon T-Bills (Letras) and liquid Bonos & Obligaciones del Estado (fixed-rate bonds).” The exception is the Treasury’s linker programme (Bonos & Obligaciones del Estado linked to Eurozone HICP excluding Tobacco), which was launched in 2014, and now amounts to 4.6% of the country’s outstanding debt.

Given its profile in the market, Spain does not speak to bookrunners too far ahead of issuance. For its most recent sale, it instructed its syndicate group just a few hours before announcing the mandate on June 25. The group consisted of Barclays, BBVA, BNP Paribas, HSBC, JPMorgan and Santander. “Our primary dealers are used to the process; they can assume battle stations quickly and efficiently,” says Mr de Ramón-Laca.

Immediately following an announcement at 2pm on June 25, the dealer group starting receiving indications of interest. By the next morning, the shadow book had reached €11.5bn. With so much information on Spanish debt already in the market, the Treasury felt it could proceed without initial price thoughts and opened books immediately at mid-swaps plus 57 basis points (bps) area. Later in the morning of the June 26, the book grew to €20.5bn before closing at midday with a final size of more than €24bn and 290 orders. The final price was set at mid-swaps plus 55bps, equal to a re-offer yield of 1.457% and a price of 99.467%.

“We’ve had bigger books before but every transaction is the result of a very specific set of circumstances,” says Mr de Ramón-Laca, who adds that the team was happy with the timing and the syndicate’s execution. “It is a tribute to the capital markets industry that we are now able to build, allocate and price a more than three times oversubscribed, €7bn benchmark transaction in a safe and compliant manner – all by Madrid lunchtime!” he concludes.