On Wednesday, February 8, Spain made a bold move. Having witnessed the January renaissance of a new issue market that had defied the almost two month closure that preceded it, the country opted to syndicate a 4bn tap of its 5.85% January 2022s.
It was the borrowers first syndication since March 2011 but it rammed home the message that Spain had market access despite the negative sentiment that had surrounded the European periphery throughout 2011 and continues to dog it today.
Spain could have taken the option of bearing down on its primary dealers to take down ever greater positions. But those dealers say that in fact it took a much more sensible option.
"Spain has not leaned hard on its international primary dealers," says one head of capital markets. "It is hard to know if that is true for the big domestic primary dealers but the 10 year syndicated tap done earlier in the year was a sensible trade to do compared to a new deal. They showed they had market access and it was the right thing to do."
In the event, the trade did more than demonstrate mere market access. Spain took 8bn of orders for the bonds and increased international participation, particularly outside Europe, from around 18%-20% to 33%.
Such courageous action has been typical, in many eyes, of the way in which Spain has attempted to tackle the problems in its banking sector, public accounts and economy. It has also front-loaded issuance this year taking the ready money that was available in the first quarter when the European Central Banks longer term refinancing operation (LTRO) provided a shot of cash supply for investors to invest.
One bank estimates that front-loading left the country 30% of the way towards its 90bn funding target for the year after only six weeks had passed. Such an aggressive start has left Spain able to cut its typical auction size from around 3.5bn to 1.5bn-2bn. leaving it less vulnerable to the continuing volatility in the Bonos market. By the end of May, Spain had raised well over half its 2012 target.
That is just as well, because Bono yields and spreads have had some hairy moments this year (see chart). Unlike in 2011, though, yields have tended to fall after a spike. But as Bonos asset swap levels show, the Spanish government may not be winning the battle for investor confidence, particularly overseas.
"The problem for Spain is that there is no great love for its debt internationally," said a head of debt capital markets. "It isnt beyond the realms of possibility that Spain could need EU assistance. They must plough on and keep taking the pain."
Others highlight the work that Spain has already done, but stress that investors are still waiting to see what impact the many proposals will have.
"The central government has made significant plans for fiscal adjustment and restructuring, taking up the challenge in a way which reflects well against historical examples," says Lee Cumbes, head of frequent borrower origination at Barclays. "Spain has made some progress, but also sees that promises arent only enough at this moment, so will need time to demonstrate execution and the effectiveness of its commitment."
As well as having to deal with an economy stuck with 25% unemployment and GDP growth of -0.4% year on year at the last count in May, Spain is also contending with the indebtedness of its regions and a horrific albeit under reconstruction banking industry.
"The country has no economic growth, high unemployment and the bad loans in its banking system keep rising," says a senior capital markets banker. "But it recognises that having a stable banking system is a prerequisite for a stable economy and it has addressed the problems in its banking system well.
"Unlike Greece, Spain didnt fudge it to join the euro and it is trying to maintain its credibility to stay there."
Spains autonomous regions have increasingly found themselves denied capital markets access as the eurozone sovereign debt crisis has continued. The Spanish central government has taken strong measures to address regional financing. First, it set up a 35bn scheme to provide cash to regions and municipalities for them to pay their suppliers with thereby neatly creating a 35bn economic stimulus package.
At the autonomous region level, the central government has inserted itself into the financial process by paying closer attention to regional budgets. It may even go as far as taking on regional funding, say some bankers, although it is unclear how this arrangement would work or when it would come into place.
Regions funded by either the central government (as in the UK, where local authorities borrow from the Public Works Loan Board) or through a separate agency that raises money itself in the capital markets (as in the case of Nordic borrowers like Municipality Finance or Kommuninvest) are well established.
But adding tens of billions of euros to the central government funding target would not be an easy decision for a country that is already having a tough time persuading international investors that its reforms will work.
The other borrowing sector dragging down Spanish prospects is its banks. Beset by bad loans, banks are in desperate need of recapitalisation. Providing that money now would probably bankrupt the sovereign, but drip feeding it into the system over time would still leave Spains banks without sufficient ability to borrow themselves.
That would have repercussions for the sovereign too in terms of where it could place its debt, should international buyers turn away from Spain in greater numbers. As a percentage of total assets, Spanish financial institution holdings of government bonds have previously been higher than they are now, rising to perhaps 12%, compared to estimates of about 7% now.
"The capacity is there for Spanish banks to continue buying," says Cumbes. "Of course, there are ever-changing ways to assess and monitor what is their desirable position, with a different level of focus on these elements currently."
One outlet for finding bank financing from the capital markets would be through the Fund for Orderly Bank Restructuring (FROB), a Spanish agency. However, the way in which Spain will approach its bank recapitalisation is a fairly opaque matter, not least because FROB is already thought to be sitting on billions of euros of cash.
"FROB wont necessarily have to come to public markets in the event it is asked to fund a bank recapitalisation," said a head of debt capital markets. "The Spanish have found many ways to finance banks and I wouldnt be surprised if I was surprised again."
Nonetheless, Spains agencies have proved that they are flexibly enough to be able to take advantage of markets when sentiment swings in favour of the country.
"Spanish sovereign issuance is largely governed by an auction timetable, but demand for Spanish sovereign risk fluctuates and can peak between auction events," says Cumbes. "The Spanish agencies can smooth the supply profile and take advantage of increased demand with their nimble use of syndications."
One agency that has been quick to act when it could in 2012 is Instituto de Crédito Oficial (Ico). "We have raised over 12bn so far this year over 60% of our target." says Rodrigo Robledo, Icos head of capital markets.
"We have to be realistic about the volatility in the market around the Spanish economy. But we have enough liquidity for the coming months and we are just pursuing our normal funding activities."
Those trades included prints of 2bn, 1.25bn, and two of 1.5bn as well as a series of taps of existing deals and MTNs in the currency. But the borrower recently expressed a desire to break out into dollars, and the idea is not beyond the realms of possibility, say SSA bankers.
"I wouldnt rule out an Ico dollar deal," says one head of public sector DCM. "Slovakia got a 10 year away in a tough market so why not Ico? US investors are credit savvy. There may not be huge demand in the secondary market for Spanish credits in dollars at the moment but often, the big enquiries only come to the primary market.
"It is not a trade for now we need more positive macroeconomic developments. But it is not a ridiculous idea."
Indeed, Ico has in line with a number of its SSA peers stepped up its investor relations work in an effort to appeal to as broad an audience as possible. "We have increased our marketing activities," says Robledo. "It has become important to be active about going to see investors.""Investors are asking about the scheme for paying unpaid supplier invoices on behalf of Spanish regions," says Robledo. "Ico runs it and provides 20% of the funding for it. They also want to know about our commitment to the regions and our opinions of the economic reforms in Spain."
But such ambitions inevitably drew criticism from some market participants. "I do not get why they did this," said one senior SSA banker at the time, away from the mandate. "Spains auctions have been successful this year and they have been able to print much more than the market expected so they have proved they have market
"They didnt need to do this messy tap with six lead managers. The method of pricing was really poor and must have upset investors.
This banker argued that Spain should have tapped the bond through an auction and then done a new 10 year issue in March or April.
"I like Spain as a credit and it is clear that others are of the same opinion as Spanish spreads have come in by 150bp in the last month and a half so am not criticizing them just for the sake of it," the banker added. "I just think they took the wrong decision here."But as the year continued, so volatility increased and windows for issuance grew fewer and further between. "Anything new in the market gets criticised," says one of the taps lead managers. "But they took 4bn of term funding. A few months on, that looks like a smart move."