Nomura Holdings, Japan’s largest investment bank, was unfortunate in its timing last year when it slashed its exposure to Italian government debt.
Between September 30 and November 24, Nomura cut its total exposure to Greece, Ireland, Italy, Portugal and Spain from US$3.55 billion to US$884 million. Most of the reduction – from US$2.82 billion to US$467 million – was for Italy. The bank’s intent was to stem further losses from the sovereign debt crisis in the European Union.
Less than a month later, the European Central Bank (ECB) helped trigger a spectacular bull market in Italian and Spanish debt by flooding the banking sector with cheap money. The ECB lent €489.19 billion (US$645.3 billion) to 523 EU banks at 1% interest for three years.
Within weeks, Italian and Spanish yields tumbled and bond prices soared.
At the end of last year, yields on Italy’s 10-year bonds hovered around 7%. But from the beginning of the year to the end of February, they had fallen 6.6 basis points to 5.37%.
The drop was just as dramatic for Spain, and the Tesoro, or Spanish public treasury, rushed to take advantage of the cheaper borrowing. In the first seven weeks of 2012 the Tesoro offloaded €30.3 billion (US$40 billion) of medium- and long-term bonds, one-third of the issuance it had previously projected for the entire year.
Foreign investors, including from Asia, returned in droves. Close to 80% of investors in a €4 billion 10-year syndicated reopening of Spain’s January 2022 bond, priced on February 8, were from outside Spain. The allocation was “almost exactly the opposite to a similar deal last year”,
a banker at one of the lead underwriters tells Asiamoney.
“The general European space is doing much better than even a few weeks back,” says Martin Weber, who is in charge of sovereign, supranational and agency (SSA) origination at Goldman Sachs in London. “If you were speaking to issuers, traders or portfolio managers in the middle of December, you would have seen a pretty bleak picture.”
After months of austere headlines and troubled markets, Europe’s top-ranked issuers have never had it so good.
Dark days
Stefano del Punta, treasurer at Italy’s biggest retail bank Intesa Sanpaolo, recalls the dark days of December with a shudder.
“We were coming out of the worst six months of senior issuance we have probably ever seen in our lives. European banks in general, not just on the periphery, were having huge difficulties in selling any kind of unsecured bonds. The central bank was saying, ‘OK, we’ll give you three-year money, because we don’t want you to deleverage. We don’t want you to take credit out of the economy. Otherwise, the economy will enter recession and we will get into a vicious circle where everyone is worse off’,” Del Punta tells Asiamoney.
“The real risk, which has been averted, was that good banks, like ourselves, or Santander, or the French banks, would have been obliged to shrink their lending business in order to preserve liquidity.”
Intesa borrowed €12 billion in the ECB’s long-term refinancing operation (LTRO). The amount was the same as that of Intesa’s international bonds due to expire in 2012.
“Our thinking was quite clear,” Del Punta says. “Even if we had been unable to go to the international market, we wanted to be in a position to pay back what we had borrowed without having to reduce our lending.”
In the event, Intesa was able to issue in February the first senior unsecured benchmark from a peripheral eurozone bank with a longer maturity than the ECB’s three-year LTRO. Demand for the five-year bond exceeded the €1 billion target by 120%.
On February 29, the ECB’s second LTRO drew about 800 EU banks to apply for a total of €529.5 billion, on the same generous terms as before. Intesa asked for double what it had borrowed in December.
The Milan-based bank said it would use the money “to optimise our liability structure, grant loans in support of the economy, as well as invest in Italian government bonds with an average duration of less than three years”.
Critics of the LTRO largesse say it is funding a massive carry trade by European banks, instead of investment in jobs and economic growth as promised by ECB President Mario Draghi.
A senior staffer at one UK bank that is also lapping up the LTRO money disputes the alleged scale of the carry trade, but acknowledged that its arithmetic could be compelling.
“Banks buy these bonds and post them to the ECB, and then they just earn the interest because the funding cost is so little,” he explains. “At the start of the year, Spanish yield was more like 4%, and in November three-year spreads were 6%. So if you bought it then and put it into the LTRO, you would have earned yourself 5%.”
Changing public perception
Ignacio Fernández-Palomero, head of funding and debt management at the Tesoro in Madrid, feels that Spain deserves a little more credit than that for its rising appeal with investors.
He notes that the change of Spanish government on December 23 and its “front-loading of reform measures” were responsible for “a change in the market perception of the creditworthiness of Spain”.
Since the first package was approved on December 30, “every single Friday there has been a new reform package released by the government”, he tells Asiamoney.
These have covered everything from public finances and the financial sector, to reform of the labour market, which is “the real challenge of the Spanish economy, given the 2.3% unemployment rate we have now”, he adds. “We have a continuous commitment to deliver the reforms demanded by the markets.”
He does not ignore the LTRO. “That has brought a lot of liquidity and additional demand for bonds, not only for the Kingdom of Spain, but for other issuers as well. It also signals to the financial sector the commitment of the ECB to alleviate the credit crunch in the eurozone, and spurs lending, including interbank.”
EU progress on a Greek debt deal has also removed some of the pressure on Spain.
“Spain has always been billed as the next country to be hit. Even since the beginning, at the end of 2009 and beginning of 2010, we were very much subject to contagion from the Greek episode. Then we became also subject to contagion from the Irish episode. Then it was from Portugal. And always in the analysts’ reports we were to be the next one,” he says. “The Greek deal should create a lot more stability in the eurozone market.”
Gallic gain
France is another country whose bonds have benefited, a fact all the more interesting given the recent loss of its coveted ‘AAA’ rating from Standard & Poor’s.
As of February 22, Agence France Trésor, the country’s debt-management body, had already sold 22.2% of its planned issuance of €178 billion in medium- and long-term euro-denominated debt, according to AFT chief executive Philippe Mills.
The average coverage ratio was 2.3, and the average cost of funding debt of more than one-year maturity had fallen to 2.42% since January 1. If it remains at that level for the rest of this year, it would be the lowest French debt yield since the creation of the eurozone, Mills added in an email sent to Asiamoney.
Mills credited the LTRO for helping “to reduce significantly tensions on financial and interbank markets by alleviating the refinancing pressure for European banks in 2012, favouring the supply of new loans to the real economy and indirectly easing the purchases of peripheral sovereign bonds by European banks (mainly Spanish and Italian bonds)”.
AFT has no detailed breakdown of French debt held by Asian investors, as “there is no obligation for investors to declare their position”. According to reports from primary dealers, however, Asia accounts for between “30% and 40% of net buying of French bonds”, mostly by Asian central banks and sovereign wealth funds, Mills said.
During AFT’s latest roadshow in Asia, “investors did not express any particular concern about French economic fundamentals and capacity to absorb external shocks after the recent downgrade by S&P, or about France’s ability to reduce its deficit and control its debt trajectory”, Mills insisted.
Dealing with a downgrade
Another prominent top-ranked victim of S&P’s downgrade pen was Rabobank, the Dutch cooperative bank that often tops the league tables of non-SSA European issuers.
It lost its AAA status in November as a reflection of S&P’s new ratings methodology and Rabobank’s reliance on the Dutch market. To sweeten the pill, S&P points out that Rabobank is still its highest-rated commercial bank.
“We came into the crisis as a triple ‘A’-rated bank, and were very much viewed as a government or agency surrogate. That has obviously changed fairly dramatically,” Michael Gower, head of long-term funding at Rabobank, ruefully tells Asiamoney. “We are now viewed, firmly and squarely, as a ‘European bank’. Obviously, everything European has been tinged with a little bit of suspicion.”
The contrasting good fortune of Germany’s Kreditanstalt für Wiederaufbau (KfW) during the crisis (see box on page 38) makes the fall from grace more galling.
“In the old days, we used to compete with the likes of KfW, and say: ‘A Rabobank [issue] is as good as a KfW, but you’re going to get a few extra basis points’. People viewed Rabobank as very much a safe-haven credit. Today the view is that Rabobank is a ‘European bank’ with all the risk that carries, and KfW isn’t regarded in that light. So I think there is a real gap from a spread point of view.”
Yields on Rabobank euro bonds with maturities in 2017 are between 2.662% and 2.742%, compared with yields on KfW bonds maturing in 2017 of between 1.412% and 1.501%. The yield on a comparable German Bund is 0.757%.
Rabobank recently pioneered relatively high-risk, high-yield contingent convertible bonds (CoCos) targeted at wealthy Asians.
“Private banks in Asia, mostly owned by Western banks, so far have been the most receptive buyer base,” Gower says. High-net-worth Asian customers “are hungry for coupon, they are in search of yield, and are ready to take relatively high risk”.
Gower adds: “It hasn’t been dominated by Japan. I would say it has been dominated by centres such as Hong Kong and Singapore.”
Jean-Marc Mercier, global head of debt syndicate at HSBC, has a similar profile for Asian bond investors: “The majority of Hong Kong-based institutional clients look for more punchy returns and are more interested in trading than the Japanese institutions, who tend to be long-term investors and favour quality SSAs.”
Eastern European experience
At the other end of the European spectrum from Rabobank in the Netherlands is Poland. The eastern European country was until quite recently considered an emerging market, and is rated A2/A-/A- by Moody’s, Standard & Poor’s and Fitch, respectively.
However it has also been less directly impacted by fears surrounding Greece. In fact the eurozone sovereign debt crisis has proved a blessing to its treasury.
“Frankly speaking, we are all the time benefiting somehow, at least on the fixed income market,” Anna Suszynska, deputy director for public debt at the Polish Ministry of Finance, tells Asiamoney. “Non-resident holdings of Polish bonds issued domestically in zloty [the local currency] have been increasing during the crisis. Last year, the net inflow was 26 billion zloty (US$8.35 billion). In 2010, it was a record 46 billion zloty (US$14.78 billion).”
Suszynska attributes Poland’s appeal to foreign investors to the positive growth and “resilience” of the Polish economy since the global financial crisis of 2008.
Being outside the eurozone also probably helps. Spreads on Poland’s asset swaps and credit default swaps are much tighter than for euro member state Slovenia.
Last year Poland decided to test its appeal with a ¥25 billion (US$306 million) bond targeted at Japanese retail investors.
Daiwa was the lead underwriter for the samurai bond issue – offering proof that at least one Japanese bank could benefit from the debt needs of European borrowers.
