Spain has come a long way in the last few years. Nowhere else
has EU convergence had such a profound effect - not just in the
country's economic fundamentals, but in the attitudes of
international analysts and investors and, even more importantly, in
the renewed confidence that now reverberates throughout the
Buoyed by this sea change in perceptions, Spanish issuers - led by
the Kingdom of Spain and government agency ICO - are taking
advantage of the opportunity to broaden their reach in
international capital markets and set new benchmarks.
And international houses are more eager than ever to win Spanish
mandates, keen to feed a growing global investor base that views
Spanish assets as providing not just good value in a pan-European
context - but also a unique exposure to Latin America. Philip Moore
"I like Spain," wrote Barton Biggs in March. And how. Seldom can
Morgan Stanley Dean Witter's idiosyncratic strategist have written
in such glowing and hyperbolic terms about an economy.
Enthusing under the title "¡España es Magnifica!", Biggs called Spain "in many ways the most luscious, delicious essence of the euro bubble story. The extraordinary circumstances of the run-up to a single European currency enabled Spain to enjoy the best of all possible worlds: strong growth, declining inflation, and falling interest rates."
Biggs does not have a copyright on his affection for Spain, which is shared in virtually every quarter. Other external economists also like Spain - and, in many instances, appear to like the country's economic prospects more than the government itself.
In April, JP Morgan pointed out that the government had increased its official forecast for GDP growth in 1998 to 3.7%, but added that "our view is a still a little more upbeat", pencilling a growth target for the year of 4.1%.
"We share the government's view that investment will be buoyant this year, but we also believe that the conditions are ripe for further acceleration in household spending beyond last year's 3.15% growth rate," added the US bank.
Partially as a result of these strong fundamentals, equity analysts also like Spain. It offers that rare combination of liquidity (which is pumping all European stockmarkets) twinned with growth.
Additionally, providing an almost unique play on Latin America, a number of Spain's leading quoted companies offer an indirect exposure to a vibrant emerging market which appears to have come through the Asian crisis more or less unscathed.
Equity investors, be they local or international, also like Spain, which is why the market rose by more than 40% in the first quarter of this year alone. Bond investors like Spain, which is why the spread between Spanish and German government bonds, measured not so long ago in triple digits, has all but vanished - although a small spread seems likely to remain in place for the foreseeable future.
Salomon Smith Barney noted in a recent update: "10 year bond yield spreads in Spain and Portugal versus Germany virtually have converged to the expected post-Emu level. Despite relatively low debt to GDP ratios, bond yield spreads versus Germany probably will remain at about 10bp-15bp in Emu, reflecting poorer liquidity than in mainstream markets.
"By contrast, short-dated bond yield spreads should narrow further in coming months, as short term interest rates fall."
Rating agencies love Spain, because so many domestic financial and corporate institutions are turning for the first time to the international capital market that they have created an unprecedented demand for new ratings.
Five banks established Euro-MTN programmes in 1997 alone. Many other Spanish issuers are in the MTN pipeline - establishing programmes as a stepping stone to greater use of international markets.
Even Spain's unemployed - of whom there are more in relative terms that in any other EU member state - are beginning to like their country more than they have done in the recent past.
Unemployment - described in the Biggs encomium as "the cancer in society, particularly because of its pernicious effect on the young" - dipped below 20% earlier this year for the first time since 1992, to 19.63%.
Spain's jobless will come to like their country even more if, as prime minister Jose Maria Aznar has boldly predicted, unemployment "disappears" within the next three to four years.
This is certainly over-exuberant political rhetoric, although local economists agree that Spain's unemployment numbers are heading in the right direction.
"Stronger economic growth will result in greater job creation," notes BCH's April update on the Spanish economy. "BCH estimates more than 350,000 new jobs will be created in 1998 and in 1999 (average growth of around 3.3%)."
Underlying these trends is a palpable sense of confidence in Spain - which, as Biggs reminded his clients in March, is a new phenomenon. Historically, he noted, Spain was characterised by "unstable, dictatorial governments, a weak currency, high inflation, and a poor performance by long term financial assets."
This most striking evidence that this new confidence is reverberating around the international capital markets came in February, when the Kingdom of Spain redefined the parameters of the nascent euro-denominated bond market with the launch of the sector's first 30 year bond.
Led by Barclays Capital, Credit Suisse First Boston, Deutsche Morgan Grenfell and Santander, this Eu1bn 2029 issue is fungible with the Pta333bn ($2.15bn) domestic 30 year bond auctioned by the Spanish Treasury at the beginning of January.
This was a follow up to another landmark issue from Spain, launched in July 1997, when the kingdom unveiled what was then the largest transaction denominated in euros to date - an Eu1.5bn10 year issue led by BCH, Santander, Paribas and SBC Warburg. This had been a stellar performer, tightening from its original spread of 15bp over the OAT at launch to 10bp by early 1998.
Probably the most impressive element about this year's new 30 year benchmark was that by effectively launching into a vacuum (with no comparable benchmarks in the market), Spain was effectively able to define its own pricing without reference to any other European sovereign.
This was an unthinkable initiative in years gone by, when Spain would automatically have been regarded as Germany or France plus a fistful of basis points.
"We thought that launching a 30 year bond was a very elegant way of allowing Spain to get away from the underlying comparison with France and from the conventional idea that Spain had to pay a premium over France," says Roman Schmidt, managing director at co-lead Barclays Capital in London.
Naturally, Schmidt adds, the bond needed to be priced over the only existing benchmark which made any sense, which was the April 2022 OAT, with the spread set at 15bp over the French government's outstanding Ecu issue.
"But the important point about establishing the 2029 maturity," he explains, "is that the spread reflects the additional seven years on the euro yield curve, rather than any credit differentials between Spain and other European sovereigns."
Other bankers agree that the significance of the Spanish 30 year issue is that it has removed, almost at a stroke, much of the perceived differential between Spain and, for example, France.
The proof, of course, will come as and when France launches a euro-denominated 30 year bond of its own. But one banker says: "I don't see how France could price a 30 year bond much below the Spanish benchmark.
"By definition, the terms of the EU growth and stability pact mean that there ought to be almost no difference in the longer term outlook for the member economies."
Schmidt says that aside from establishing a new benchmark at the long end of the new euro curve, the 30 year maturity made sense given the considerable demand which Barclays and others had already identified - through, for example, a previous 30 year Deutschmark issue for Baden-Württemberg - for longer dated paper among European institutions.
"It was the old story about institutions needing to secure certain returns," he says. "And the way to do that is either to move up the credit curve or up the maturity curve."
The Spanish 30 year issue allowed institutions to do the latter without compromising on the credit.
Possibly with exaggerated modesty, Federico Ferrer, director in charge of international borrowing at the Spanish Treasury, says that he does not expect to win any awards (as he did in 1997) for Spain's latest euro issue.
"We were less generous with the pricing of the 30 year issue than we were with the 15 year transaction," he says. "Last year we probably paid one basis point more than the market would have demanded, whereas this time we paid exactly what the market required." Fair enough. That, after all, is what benchmarking is all about.
But Ferrer is understandably less concerned about winning awards for his borrowing strategy than with reducing Spain's international cost of funds, which the 30 year issue seems to have achieved.
"In the 15 year maturity Spain still traded substantially over everybody else," he explains. "We thought that by issuing a 30 year bond we could flatten the yield curve between the 10 and the 30 year maturities, and this is precisely what happened."
While the Kingdom of Spain itself is a tried and tested veteran of the Euromarkets, a number of the other Spanish issuers presenting themselves to investors are not. They are training their sights on the international capital market more or less for the first time.
Perhaps the best example of this is Spain's financial agency and development bank, Instituto de Crédito Oficial (ICO), which was formed in 1971 and has assets of more than $22bn.
As recently as 1996, ICO relied predominantly on the domestic market for its funding, raising Pta500bn locally and the equivalent of just Pta156bn overseas (following the establishment in 1996 of a $2bn Euro-MTN programme, the size of which has since been raised to $4bn).
In 1997, according to ICO's financial markets manager Teresa Saez, the balance between local and foreign funding was more or less equal. By early May, in contrast, just over 60% ($1.124bn) of the $1.87bn raised so far this year by ICO had been generated from international sources.
While the lion's share of this has been accounted for by loans, international funds have also been raised through a Deutschmark private placement and via public issues under the Euro-MTN programme in Swiss francs and Greek drachma.
There are a number of reasons for the increased focus on international markets, says Saez.
First, while the vast majority of the bank's loans have traditionally been denominated in pesetas, an increasing flow of its advances are now in international currencies (principally US dollars). This is a reflection of the increasing internationalisation of Spanish companies in general and the extent of their investments in Latin America in particular.
Second, it is clear that improving international sentiment towards Spain will further lower ICO's borrowing costs in overseas public markets. So, although the easiest and cheapest way for ICO to raise funds is via private placements and structured transactions, the bank also recognises that establishing international benchmarks is a prerequisite for expanding its name recognition overseas.
A third motivation for tapping international markets is to act as a pathfinder for other Spanish issuers. This is a role that ICO has previously played in the domestic bond market, where it established a 30 year bond even before the Treasury in response to growing demand from domestic insurance companies.
In 1998 ICO has a total borrowing requirement of around $5bn, a substantial proportion of which was generated in mid-May from a groundbreaking global bond issue, the first of its kind to have been launched by a Spanish borrower.
Speaking to Euroweek just before the launch of that issue, Saez explained that the original plan had been to launch a 10 year $750m transaction.
In the event, demand for the landmark global, which was led by JP Morgan and Goldman Sachs and priced at 37bp over US Treasuries (against an indicated spread of 37bp-38bp), was such that the size of the transaction was lifted to $1bn.
The appointment of the US duo as joint leads - with ABN Amro, Morgan Stanley and Bank of America acting as co-leads - was, according to Saez, a direct reflection of the borrower's ambition of widening its investor base in the US.
She added that ICO had also contemplated issuing a euro-denominated global targeted chiefly at the US. "But we thought that the combination of a new name and a new currency would be asking too much," she explains.
Madrid bankers say that ICO has acted as a model borrower in the international markets to date, focusing more on name recognition and on dialogue with new investors than on grasping the last basis point in its pricing negotiations.
But before the launch of the issue, Saez did not appear to be prepared to compromise too much on the pricing of the global.
"I don't necessarily want the issue to be a blow-out," she said. "Because if you have a blow-out you tend to lose basis points. "The hardest part is to strike a fair balance between the requirements of the borrower and the investor, which is especially difficult in the global bond market because there are very few comparables in the sector.
"For the bonds to tighten by one or two basis points is fine, but if they tighten by five it shows you've mispriced the deal."
Despite being launched into a market hit by Asian-related spread widening and carrying a price that some bankers viewed as aggressive, the ICO global bond was readily taken up - mainly by European investors attracted by the scarcity of European sovereign paper.
Over the longer term, a ready benchmark for ICO to shoot at would be its German counterpart, Kreditanstalt für Wiederaufbau. "We're similar to KfW in many ways," Saez explains. "For example, we have a zero risk weighting from most of Europe's central banks as KfW does. "But KfW is triple-A while we are double-A, and KfW is also much better known internationally than we are, so there will inevitably be a difference in basis points between us."
This differential will inevitably narrow, however, if and when Spain's foreign currency debt ratings are raised from double-A to triple-A, as many local bankers insist that they must ultimately be.
ICO has a direct, irrevocable and unconditional guarantee from the Kingdom of Spain and its international issues benefit from the same fiscal treatment as sovereign debt, meaning that they are not liable to withholding tax.
As a result, ICO's bonds are popular among local as well as international investors as quasi-sovereign paper with a yield pick-up.
Saez is confident that ICO's global bond will serve as a benchmark for other Spanish borrowers to enter the international capital market, although for the time being many of these will be first time issuers with much more modest ambitions.
To Carlos Lopez Jall, a director at Barclays Capital in London, the single most important theme in the Spanish capital market this year has been the speed with which it has diversified in terms of origination.
"So far this year there have been more than 30 Spanish issues in the Euromarket," he points out, "compared with three or four from Italy. The number of new names looking to come to the market is enormous, although they are not necessarily issuing to raise funding, but to improve their name recognition in the run-up to Emu." EW