Core sovereigns no longer immune from eurozone

What about the good guys – the countries that have cut deficits, displayed financial probity and behaved as the European Union would like them to behave? Will any of them be impervious to the debacle that 2011 is shaping up to be? Jo Richards asks the questions.

  • 28 Jan 2011
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Germany was the safe haven of choice in 2010 but Finland, the Netherlands, Austria and the UK were also beneficiaries of the flight to quality. Belgium fits here too as far as fiscal management is concerned and Italy is included because of its deep and liquid market. But market participants doubt that any of them will survive the year unscathed unless the euro area member states deliver more clarity on the rescue packages at an early stage in the year.

"Germany could suffer because it may have to take on too much debt if the EFSF/ESM is increased," says a head of SSA debt capital markets. "And don’t forget German banks are very exposed to the peripheral countries.

"France’s credit rating has been called into question because of its budget deficit and its banks’ exposure to peripheral sovereigns while Belgium’s rating is under scrutiny because of its political mess. Finland may suffer because of competition from the EFSF and EFSM and Italy could be dragged down with the rest of periphery. As for the UK, it has a difficult few years ahead as budget cuts are implemented but at least it has its own currency and a more or less captive audience for its debt."

Germany — the anchor of the eurozone

Germany, which has taken the weight of the eurozone on its shoulders, was the ultimate flight to quality trade in 2010 as investors sought safety from the unprecedented volatility in peripheral government debt. Bund yields plummeted to record levels and are likely to remain low in 2011 but market participants fear that, if the crisis mechanisms have to be expanded to cope with other failing sovereigns, Germany, as the biggest provider, will take on too big a burden, which many market participants fear will result in underperformance of the Bund market.

With the biggest borrowing requirement in the eurozone at around Eu300bn, Carl Heinz Daube, managing director of the Finanzagentur, Germany’s debt management agency, would be forgiven for feeling nervous at raising such a large amount in what could turn out to be another difficult year for sovereign issuers. He remains upbeat, however, confident that Germany’s transparent and predictable issuance strategy will carry it through and is unconcerned about rising refinancing costs.

"There might be still a lot of uncertainties for 2011 and I wonder where the next external shock may come from but we have another 365 days for the coming year so there might be a lot of things come.

"For our issuance calendar, I’m very optimistic. It’s still a very large volume — the net borrowing
for Germany is the second biggest in history: something like Eu48.4bn. And then we have quite a significant number of redemptions, due to the high issuance last year. We will end up with another year of more than Eu300bn to fund, which is quite an amount."

Germany set the standard of how a country should operate, cutting its deficit in 2010 from Eu83bn to Eu53bn, which made it possible for the Finanzagentur to reduce medium and long term bond issuance by Eu16bn from the Eu223bn estimated at the beginning of the year.

After the sharp drop registered last year, analysts at UniCredit expect Germany to experience a more modest reduction in the federal deficit in 2011 of Eu5bn, down to Eu48bn.

Reflecting on Germany’s programme for 2010, Daube, says there were some adjustments to the issuance calendar, but they were not the result of the sovereign debt crisis.

"We started with a net borrowing amount of something like Eu80bn and we ended up with Eu60bn, but this was due to the fact that our economy grew much better than expected last year, so our government had a higher tax income, and have spent much less on unemployment," he says.

"There were next to no effects from the crisis, and we did not change our issuance calendar either. Of course there might have been some effects on the pricing level, which might have been connected to the overall crisis mode, but this is an external factor from our point of view."

Germany did not issue a syndicated bond in 2010, relying instead entirely on the auction process, but bankers expect at least one syndication this year, possibly a new 30 year index-linked bond and perhaps a foreign currency bond.


Finland revels in Nordic appeal 

  While Finland is one of the most sought-after names in the euro sovereign sector, bankers fear that debt of the non-core triple-As such as Finland will be hit by supply from new issuers EFSM and EFSF in 2011.

"Those two names will be issuing debt at EIB or EIB plus levels and they are quasi-sovereign issuers, rated triple-A, paying a decent pick-up over the likes of Finland and Austria," says a head of public sector debt capital markets.

"Several investors have already said they will be switching out of pure sovereign debt to buy EFSF and EFSM."

Teppo Koivisto, director of finance at the Finnish Treasury agrees that competition may be stronger this year.

"We see a lot of competition for the next year and there will be volatility and noise and possibly also event risk involved," he says. "But we feel that there will be very narrow issuance windows from time to time."

"As a small issuer we have to be proactive, agile and do our homework — which basically means you have to have a continuous dialogue with your banks and investors — and then we have to find the proper slot in between the issuance calendars of the large issuers."

Finland faced no such problems in 2010, its two syndicated government bonds and one dollar issue receiving broad international demand as one has come to expect for deals by this pristine credit.

"We have faced elevated funding needs, like all the other euro countries, but we don’t see that the sovereign crisis has harmed our financing or the funding programme that much," says Koivisto.

"The core of our strategy is concentrated on the euro benchmark issuance, just to provide a sufficient share of the liquidity into the market. That’s crucial for a smaller issuer, which does not have the possibility to support the enormous liquidity the larger countries can."

Both euro transactions fell short of size aspirations, the first due to oversupply and the second because investors baulked at the low yield of just over 1.75%.

But Finland’s dollar bond, a $2bn five year priced in October, was one of events of the dollar market last year. At mid-swaps less 1bp, it was the tightest five year sovereign print of 2010, the republic’s first dollar benchmark since it incorporated 144A language in its documentation, and its first dollar issue since January 2009.

The outcome was predictably strong. Lead managers Bank of America Merrill Lynch, Citi, Credit Suisse and HSBC built a book of $3bn, enabling Finland to undercut its mid-swaps flat price talk by 1bp.

Finland was able to benefit from the advantageous swap back to euros, as did several of its sovereign counterparts in 2010, achieving some 30bp through Euribor after swap, a saving of some 5bp. More dollar supply is expected from Finland this year.

The Finnish government’s borrowing requirement rose to Eu28bn in 2010, of which Eu17bn was long term funding and the balance short term bills. Koivisto expects a similar number for 2011.     

The Netherlands — crisis, what crisis?

2010 was a challenging year for the Netherlands in terms of economics as its deficit rose from 5.4% to 5.8%. Bond redemptions were also in the Eu23bn area, increasing borrowing needs to around

But, says, Peter Nijsse, head of cash management, issuance and trading at the Dutch State Treasury Agency (DSTA), the Netherlands suffered little from the surrounding turbulence.

"We are in the group of core countries where there is always demand and where it is always possible to auction your bonds," he says.

"The market also appreciates our predictability. Everyone knows when we are coming so there are no surprises, which helps to make the auction process easier. We have seen more volatility during auctions which makes pricing more challenging, but we have never seen lack of demand."

His view is confirmed by the success of the 30 year Dutch State Loan sold in May by Dutch direct auction (DDA) which attracted total bids of Eu7.256bn in two hours, allowing Eu5.2bn to be allocated at the tight end of guidance.

The DSTA expects to issue around Eu50bn of medium/long-term bonds in 2011 with two to be issued via DDA, a 10 year in February/March and a five year in May/June. ABN Amro, Barclays Capital and HSBC will act as advisers on the 10 year.

The DSTA may also issue its first dollar transaction, also using the DDA method, if arbitrage conditions are sufficiently favourable to beat domestic funding costs. Otherwise it is business as usual for the DSTA of regular monthly auctions.

"I think the market is going to be interesting in 2011 but we do not expect difficulties for ourselves," says Nijsse.

"Our outlook and budgetary position is strong so we should survive any crises going on around us. Also, being a core country, even if there is turbulence, there will be demand for core paper.

Austria — in pristine condition

Alongside Germany and Finland, Austria will be one of the few EMU countries to comply with the Maastricht criteria as its deficit will fall from 3.5% to 2.6% in 2011 and, with a borrowing requirement of Eu18bn, some Eu2bn less than in 2010, the country is unlikely to face any problems meeting its target.

And, although Austrian government bonds cheapened during the first half of 2010 as a result of the Greek crisis, they finished the year at around the same level as they started.

UniCredit analysts expect Austria to issue Eu2bn of foreign currency bonds and Eu15bn-16bn in domestic bonds with a new 10 year and possibly a new 30 year on the calendar.

France – back on track

Speculation that France’s triple-A rating may be in jeopardy surfaced again at the end of 2010 although the country is on track to reduce its deficit and has reduced its 2011 programme of medium and long term debt issuance. The cause, say analysts, is fears over French banks, which are the biggest holders of debt issued by peripheral sovereigns.

French CDS rose to an all-time high of 105bp in December, three times the level recorded at the beginning of 2010 and wider than the CDS of, for example, the Czech Republic, implying that France may have a rockier ride this year than it did last.

According to the Agence France Trésor, France will in 2011 trim its medium and long term debt issuance to Eu184bn, net of buybacks, thanks to buybacks conducted in 2010 and a slimmer budget deficit. This compares to Eu188bn issued in 2010.

Around 10% is expected to be issued in index-linked instruments with a new 15 year OATei linked to EMU CPI and a new five year OATi linked to domestic inflation.

There will be no stunning 50 year conventionals for France in 2011, however. The AFT did that last year when it issued a Eu5bn 2060 OAT, which was priced at the beginning of March. The deal is only the second 50 year to be issued — the first, also from France, was issued in 2005.

Lead managers Barclays Capital, Deutsche Bank, JPMorgan and Société Generale said they were nervous ahead of the transaction given the low yield environment and the peripheral rumblings in the background. But, after holding investor presentations in the UK, the Netherlands and Scandinavia to ascertain the depth of demand, it was concluded there was demand for such an instrument. And so it proved. The deal was launched with guidance of 2bp-4bp over the 2055 OAT and rapidly garnered a book of over Eu8bn, allowing pricing at plus 2bp.

Analysts predict that France may issue two new long term benchmarks — a 15 year and a 30 year.

But what bankers really hope is that the advantageous swap arbitrage for euro takers in the dollar market might tempt France to issue its debut dollar transaction in 2011.

2010 was quite pain-free for France although its trading levels came under pressure at certain points, particularly in the second half of the year, fuelled by a relatively poor fiscal performance and the rumour regarding the sustainability of its triple-A rating. However, after announcing budget cuts for 2011 to bring the deficit down from Eu150bn to Eu90bn in 2011, France appears to be back on track, say analysts who are confident that the country will maintain its prime ratings.

Belgium – losing the battle?

While Belgium cannot be criticised for managing its finances — it reduced its deficit from 6% to 4.8% in 2010 — there have been concerns about its political situation as the country has been without a government since June, which prompted Standard & Poor’s to place its AA+ credit rating on outlook negative in December.

Along with many of its neighbours, the kingdom was caught up in the extremely volatility, which materialised in a substantial increase in spreads versus Germany, particularly towards the end of the year when illiquidity magnified market movements.

"We are trading at 137bp versus Germany compared to around 54bp at the beginning of the year, a level we have not seen for a very long time," says Anne Leclercq, director, treasury and capital markets, at the Belgian Debt Agency.

"For most of the year we saw our spreads versus Germany hovering more or less in their natural state, which is between France and Italy but closer to France. During the crisis in May, we saw an increase but we were still closer to France. However, in December our spreads went more in the direction of Italy than remaining in the neighbourhood of France so we were losing our space as a semi-core country. I can only hope that a less volatile market is in place this year, together with positive expectations with regard to a new federal government so as to create a receptive environment for issuance in 2011."

Belgium plans to issue Eu34bn in OLOs in 2011 and Eu4bn under the MTN programme with three syndicated deals scheduled, including a 10 year in early January, and eight auctions.

Leclercq says the size of the auctions will depend on demand in order not to weigh too much on the market and be responsive to what maturities the market is asking for.

"We want to give the market what it really wants to ensure the secondary market does not suffer from primary market supply," she says. "We need to be very responsive to the market because 2011 will not be an easy year. We will engage with investors in order to read the market correctly."

Italy — the strongest of the weakest

While Italy is viewed as a peripheral sovereign, the enormous size and liquidity of its bond market, affords it a place alongside Germany and France. And of the non-core issuers, Italy has been least affected by the volatility even though it has one of the largest borrowing requirements of any of the euro area member states with some Eu235bn to raise in 2011.

Unlike the other peripheral countries, Italy’s rating has remained stable at Aa2/A+ and it will be the only country in the EMU where domestic bond redemptions will decrease sizably in 2011 — to Eu155bn from Eu172bn. It is also expected to post an Eu8bn decrease in its Eu80bn deficit.

According to UniCredit research, Italy will be busy in the foreign bond market, with the equivalent of Eu5bn-Eu7bn of issuance, while domestic bond issuance should amount to Eu226bn-Eu230bn, leading to a Eu15bn drop in net supply from 2010.

Trevor Welsh, senior fund manager, fixed income sovereigns, at Aviva Investors takes the view that Italy will survive the crisis mostly unscathed.

"While Italy suffered a little in the crisis, it has been less volatile than its counterparts," he says.

"Financial control within Italy appears to be very strong and unlike Spain, Ireland and the UK, it has not seen a massive property bubble. The problems experienced by the Italian banks do not stem from bad loans on the local property market although here have been bad investments in overseas CDOs and derivatives and the like. Therefore I tend to the view that Italy will be less affected."

His view is echoed by Axa’s Chaney. "In 2011, if markets start to test the credibility of the euro and Spain is affected, the countries that could be tested are Italy and Belgium with Italy being the biggest risk," he says.

"I believe Italy is relatively safe because its national debt is largely held by domestic institutions and ultimately domestic savers. However, the national debt is not far from 120% of GDP and that held by foreign investors not far from 50% of GDP, which shows that Italy, too, could be tested."

Maria Cannata, director general of public debt at the Italian Treasury, says Italy was not particularly affected by the sovereign crisis in terms of the type of instruments or general policy or the way in which it conducted its activities during 2010 but some small changes were needed at certain stages.

"We have continued very regularly," she says. "For sure the peaks of volatility — especially in May and June — produced some small adaptations, in particular to the size of one year T-bills, because in that period there was an excessive widening of spreads in that part of the curve — between one and two years — so we reduced a little the amount of bills auctioned.

"But it was really a minor effect and we were able to offer more long dated bonds in the same period to compensate. We didn’t see any particular effect in our issuance activity overall."

Cannata says that the main action was most often on the secondary market, particularly in May when the bid/ask spread on Italian bonds widened sharply.

As far as syndications were concerned, Italy had a good 2010. A $2.5bn global bond in January marked the issuer’s first five year dollar bond since 2004 and a $2bn three year, priced in September in the middle of one of the peaks of volatility, attracted demand from a broad base of real money accounts, 75% of them located outside Europe, reflecting the global appeal of the Italian credit. Also in September in the midst of a peripheral crisis led by Ireland, Italy issued its largest syndicated BTP since 2005, a Eu6bn 15 year which garnered a book of Eu10bn.

Italy continued to issue the large majority of its bonds via auctions and only syndicated bonds with a maturity of 10 years in the nominal sector and new inflation-linked benchmarks. It also introduced a new floating rate instrument, the CCTeu which will gradually replace the old CCT.


 The UK — a currency apart

  The UK has another mountainous borrowing requirement in its 2011-2012 financial year (which starts on April 1) and while in 2010 the UK was viewed as a refuge from the political and financial turmoil in Europe, 2011 is likely to be more challenging as the country starts to feel the effect of the austerity measures introduced by the new government after it came into power in May.

Continuing problems within the eurozone will also have a deleterious effect, since, as Bank of England governor Mervyn King said in his inflation report in November: "A healthy European recovery is important to the ability of the UK economy to

"The UK has been a slight haven among some of the political storm we have seen this year and, so far, the UK has managed to get away with it," says Trevor Welsh, senior fund manager, fixed income sovereigns, at Aviva Investors.

"The economic data that is coming out is reasonably positive, the government’s programme is being implemented and, student demonstrations aside, we are not seeing big national strikes. Tax revenues have probably been outperforming expectations so the UK has had a reasonably easy year.

"The fact that the Conservative party came in, they set out a programme, got the coalition together, their programme was widely accepted and was given a seal of approval from the rating agencies, which has helped the DMO get through its funding successfully. There have been no failed auctions and the syndications went very well.

"2010 has definitely been a good year for the DMO. But 2011 is likely to be more difficult as the VAT rate rises and public sector worker pension contributions will rise but their wages will not. Also, one of the key points raised by Mervyn King in his inflation report is the volume of bank refinancing that needs to be done and that continues to be a big longer term risk for the bond market next year."

Robert Stheeman, chief executive of the debt management office, also remains cautious.

"We are conscious of the fact that, while the market for Gilts has been pretty robust in 2010, we still have a lot of borrowing to complete in the next couple of years, and we do not take the current benign market for granted," he says.

"There are always unexpected shocks so we have to watch things very carefully. We will be keeping our ear very close to the ground, talking to the primary dealers, talking to the investor base to ensure that we minimise the risks to our borrowing programme.

I hope that the trusted and tried principles of predictability and transparency will continue to stand us in good stead."

Projections for 2011 give the Debt Management Office (DMO) around £169bn of gross borrowing, similar to 2010. The official figure will not be known until the Budget on March 23 but Stheeman says it is fair to say that financing requirements will remain at elevated levels for the next two years.

"We are on track for what is planned for the current financing year ended on March 31, 2011," he says.

"Gilt sales are virtually unchanged at £165.2bn compared to the £165bn set out at the time of the Budget in June. Projections for the next financial year 2011-2012 give us a gross financing requirement of £169bn, falling to £144bn in 2012-2013 and to £117bn in 2013-2014."

Auctions will remain the DMO’s preferred method of issuance and Stheeman could not confirm how many syndications there are likely to be, if any.

"Whether or not syndications will be used ultimately that will be a ministerial decision and will be in next year’s remit but next year’s borrowing requirement is quite similar in size to this year and our programme as it currently stands seems to be working well."

But based on the success of the syndication programme so far under which the DMO raised £31bn in 2010 in six transactions, bankers are confident the method will be used in 2011. One such is planned for January, a long dated index linked Gilt maturing in the 30 to 50 year area.

At least having linker issuance referenced to CPI inflation rather than RPI for pension index purposes has been taken off the table for the moment after the Department of Work and Pensions announced in December it was no longer minded to introduce legislation to force pension firms to change from CPI to RPI.

Arguably the most successful syndication in 2010 was the £8bn 4.25% December 2040 transaction issued in June. It is the biggest sovereign deal in history, which given the parlous state of the sovereign market at that time, was an impressive achievement. The ability to price a trade of such historic dimensions despite the troubles in the eurozone was hailed as a watershed moment and underlined the perception of the Gilt market as a safe haven.     
  • 28 Jan 2011

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
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1 Barclays 20,041.00 34 7.66%
2 Citi 18,215.95 71 6.97%
3 JPMorgan 16,098.67 49 6.16%
4 Goldman Sachs 15,821.46 36 6.05%
5 HSBC 15,568.27 47 5.95%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
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1 HSBC 48,528.41 214 6.32%
2 Deutsche Bank 44,075.51 161 5.74%
3 BNP Paribas 41,452.79 240 5.40%
4 JPMorgan 37,278.65 134 4.85%
5 SG Corporate & Investment Banking 36,258.27 187 4.72%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
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1 Goldman Sachs 1,607.28 5 28.64%
2 Credit Suisse 1,301.65 4 23.20%
3 BNP Paribas 522.35 4 9.31%
4 SG Corporate & Investment Banking 444.17 3 7.92%
5 Morgan Stanley 331.78 2 5.91%