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Non-core sovereigns: battling back from the wilderness

18 Jan 2012

Such has been the tumult in European sovereign debt markets that it has been impossible to achieve consensus even on the very act of defining who is a non-core European sovereign and who is not. One certainty, however, is that the non-core is not a good place to be as a borrower. Ralph Sinclair studies the experiences of Belgium and Italy, and their plans to extract themselves from their capital market woes.

To assess the prospects for non-core European sovereigns in 2012’s capital markets, it would be useful in the first instance to define which countries are in that group. It is not an easy task. Certainly one could include the European periphery of Spain, Portugal, Italy, Ireland and Greece. But since the summer a whole host of other countries have warranted, and often earned, inclusion.

A year ago, the only real debate was whether PIIGS should have one ‘i’ or two. That is to say, should Italy be included. There is no longer any doubt that, since the summer, Italy has been firmly thrust into the periphery. But depending on who you speak to and at what time, that group now includes countries like Austria, Belgium and even France.

What is clear though is that no country wants to be considered non-core. It is bad for business. Yields spike as investors begin to flee bond positions and before long all meaningful trading ceases which exacerbates the yield problem as they gap higher on ever smaller tickets. Typically at this point defenders of that particular credit will say the problem is not one of solvency but liquidity. But if nobody will trade your bonds for long enough, it becomes a solvency problem.

Borrowers have felt that it has hardly been rational decision-making that has thrust them into the non-core group.

That in turn has made for some hairy experiences in the market as government auctions have moved from dull routines to events of high tension for borrowers. Meanwhile, syndications have been all but impossible.

"It was nerve-wracking when the last OLO auction was coming up and we saw absolute yields rising in an incredible way and our spreads versus Bunds increased to their highest level ever," says Anne Leclerq, director of treasury and capital markets at the Belgian Debt Agency. "The 10 year OLO was yielding 5.85% as an absolute yield and the highest spread was around 355bp, a widening from which is coming from 3.48% and 77bp respectively on April’s tight levels."

Italian fiasco

Italy has been the main focus of the European debt crisis since last summer when its yields rocketed over 7% and the European Central Bank had to step in to take up the slack and try and reduce Italian borrowing costs. With outstanding debt of around €1.9tr, it is the one borrower that Europe cannot afford to go to the wall.

The debt crisis cost the Italians a government last year as well as extra percentage points on borrowing costs. Considering many bankers put Italy in Europe’s rock solid core at the start of the year, that is quite a shift in perception. In the 10 year sector Italy issued €5bn of its 4.75% 2021 BTP at a yield of 4.84% in February. Come July it priced €2.7bn of the same bond at 5.77%. But by the end of November, the damage was even worse as the country issued €2.5bn of 5% 2022s at 7.56%.

In 2012, the Italians only require a further €23.6bn of new funding. However, the country’s redemption profile means the gross amount of debt it needs to raise is much higher. Italy must borrow €202bn to include medium to long-term conventional bond redemptions. That figure rises to €450bn once T-Bill financing is included.

Much of that figure will be raised through BTP auctions as usual. Since the European Central Bank stepped in to the Italian market to buy bonds and suppress yields, there has been renewed international interest in the Italian market, according to Maria Cannata, director general for public debt in the treasury department of the Italian economic and finance ministry.

"The auction on December 13 was very encouraging," she says. "Our primary dealers reported large real money interest from the UK, Germany, France, the Netherlands and Asia."

But to manage their schedule in 2012, the Italians spent a portion of 2011 smoothing their redemption profile thereby ensuring they would not need to find extra large chunks of cash at particular points in the year. The borrower ran five debt exchanges and a buy-back to remove €10.108bn from 2012’s redemption schedule at various points throughout last year but particularly in its last four months as markets grew ever more distressed. The exercise took up the slack not covered by the ECB’s Special Markets Purchase Programme.

"We carried these exercises out in Certificati di Credito del Tesoro (CCT) and linker products as these are not covered by the ECB’s SMP programme," says Cannata.

Ultimately though, Cannata acknowledges that the most helpful thing that could happen for Italian government bond markets is for the investor sentiment to calm down. "We have quite a heavy redemption schedule in the first half of 2012 but it is manageable," she says. "It would be more difficult if the market were as bad as it was in November but we are more confident now. In general, we need to see less nervousness and volatility. There needs to be less reaction to political statements."

Investor bases

Italy’s primary dealers will continue to take the brunt of Italian auction supply but Cannata says they are not showing any signs of strain. "The qualitative feeling is good among our primary dealers," she says.

The borrower expects its domestic investors to maintain their large stake in the country’s financing. To that end it will introduce a new instrument aimed at domestic retail investors. The debt will be sold through the Mercato Obbligazionario Telematico (MOT) platform run by Borsa Italiana.

The sovereign was inspired by seeing Italian banks sell debt through the system — which deals with investors with online accounts — in 2011. The borrower has not decided what the new instruments will look like in terms of maturity, size or structure but is aiming to have issued its first deals by February or March.

As for institutional accounts in Italy, the sovereign is confident that another ECB measure — the new Long Term Refinancing Operations (LTROs) — will help banks free up capital to maintain their presence in the BTP market. "We have already seen that it is having a positive effect on our yields and spreads," says Cannata.

The Italians have also rejigged their auction schedule to allow for greater similarity between primary and secondary markets. "We have changed and published our issuance calendar to smooth demand over the days we are in the market," says Cannata.

It had become the case that T-Bill auctions began to take the focus away from zero coupon bonds (CTZs). Both types of security were auctioned on the same day of the three day period each month when Italy came to the market. Italy will now auction CTZs and inflation-linkers on day one, T-Bills on day two and keep medium to long-term nominal bonds for day three. It has also changed the settlement periods on T-Bills, linkers and CTZs to better align primary and secondary markets.

Regardless of what measures the Italian sovereign deploys in capital markets however, it is still the wider Italian economy that will govern overall demands for the country’s sovereign debt.

"The macroeconomic backdrop could be an important factor for Italian bonds in 2012 but that takes time to clarify," says Cannata.

Again, the ECB’s LTROs will help with this by allowing Italian banks to increase liquidity and extend credit to the wider economy thereby stimulating growth.

Italy has also engaged more with investors and will continue to do so in 2012. "We carried out a great deal of meetings in the second half of 2011 in particular," says Cannata. "We went on roadshows, visited conferences and held one-to-one meetings. But what was really noticeable was the number of investors that came to visit us in Rome to learn more. We had investors from Asia, the UK, the US, the Nordic countries and these visits are continuing into 2012."

 Syndicated struggle 
 Italy is one sovereign borrower that has a long track record of syndicated deals. However, the panic around its debt in 2011 has crippled its ability to bring syndicated deals for now.

"A syndication will be very dependent on market conditions improving," says Maria Cannata, director general for public debt in the treasury department of the Italian economic and finance ministry. "The market will need to be much more stable for us to be able to syndicate a new issue. It is very hard to pick the right issuance window without stability."

Belgium was able to bring syndicated deals in 2011 and hopes to continue in 2012. However, its experience of the process in January was illustrative of the sort of panic that swept over sovereign markets throughout the year. The Belgians were mid-way through a bookbuild on a 10 year OLO when the Dutch finance minister said that no agreement would be reached on a proposed increase in the size of the EFSF. At the time the order book topped €7bn but immediately sovereign spreads collapsed, a number of orders fell from the book or widened their bids and the borrower was only able to print €3bn from a €6bn book.Nonetheless Belgium was able to raise €40.8bn of new OLO funding in 2011 — more than the €39bn initially planned and has pre-funded for 2012 by €5bn-€5.5bn. It has also not been deterred from syndications by January’s experience or the deterioration in markets during the latter part of 2011."The plan is to do a syndication in January as usual even though from a cash point of view we would be able to wait," says Anne Leclerq at the Belgian Debt Agency. "If the market is there and there is demand, we will go ahead and be transparent and predictable and syndicate a 10 year bond."

18 Jan 2012