SSAR Issuer: Kingdom of Spain

2018 started on a high note for the Spanish Tesoro. Fresh off a one-notch Fitch upgrade to A– on January 19, it was straight out of the blocks with a new 10-year as it set out to tackle a €215bn gross borrowing programme.

That €10bn bond was no mean feat for the country’s debt management office. Only a few months before, Spain was suffering from political unrest as the central government clashed with Catalonia over the region’s bid for independence.

But that political upheaval did little to deter investors. Instead, they poured more than €43bn of demand into the deal, the largest order book in the history of Spanish government bond syndications and the second largest book in the history of the European sovereign, supranational, agency and regional market.

That investors have such a fondness for the credit is not by chance but the result of structural reforms undertaken by the government after it was granted a €100bn lifeline for its banks in 2012.

And indeed, Fitch was not the only rating agency to reward Spain with an upgrade. Moody’s, S&P and DBRS also upgraded the sovereign by one notch in 2018, taking Spain’s ratings to Baa1/A–/A–/A.

“Spain’s investor base is changing as its credit improves,” said Pablo de Ramon-Laca Clausen, head of funding and debt management at the treasury.

“Rating upgrades, especially the latest round of them, opened the proverbial floodgates to large pools of savings that previously did not invest in Spain, namely certain very high-quality Asian and European institutional investors.”

The country has wind in its sails. “Spain is growing faster than the eurozone average, with a consistent current account surplus,” de Ramon-Laca said.

“Whatever else is happening, that fundamental fact ensures that Spain winds down its national debt, provides more employment opportunities, reins in the government’s deficit and, as a result of all this, improves investors’ confidence in its credit.”

Spain’s net external debt-to-GDP has been on a downward path, dropping to 85.2% from 99% in 2015.

The private sector debt dynamics have also been moving in the right direction, going from 217.8% of GDP in 2010 to 156.4% now, below the 162% eurozone average.

Growth has also been healthy, hitting 2.5% – higher than the euro area rate of 2.1%. The country’s unemployment rate has also been coming down, to 15.3% overall. While youth unemployment remains high, it has also fallen from 2013–14 when it was at 57% to below 35%.

SAILING THROUGH THE STORM

But for all of the good economic work and ability to ride out the noise in Catalonia, it was an exogenous shock that most threatened Spain in 2018.

The storm clouds came from Italy: after the formation of a surprise government coalition between the Five Star Movement and the League, the spread between Italy’s 10-year benchmark and Germany’s blew out.

From 113bp at the end of April, it hit 273bp in May when concerns first flared up. It continued to widen to the low 300s as a spat between Italy and the European Commission over the country’s budget showed no signs of going away.

And while Spain was to an extent buffeted by the headwinds, its spreads stayed relatively firm. Its 10-year widened by 64bp versus Germany’s 10-year to 129bp at the end of May, where it has since stabilised.

That stability came even though Spain that had to navigate its own political crisis after prime minister Mariano Rajoy was ousted from office in early June after his party was implicated in a corruption scandal.

“It is true that Italian politics provoked some volatility in the SPGB market, but the market proved very resilient and was rapidly prepared to absorb new issuance in early June,” said de Ramon-Laca.

“The change in the Spanish government had no impact on the markets, and it did not change the Treasury’s plans either. It was a textbook example of how to do a seamless political transition.”

Just over three weeks after Rajoy’s ousting, Spain was back in the market with another 10-year benchmark albeit in smaller size – at €7bn on demand of more than €24bn.

The deal put to rest fears that volatility would spread like wildfire, also giving the market the first glimpse into investors’ appetite for peripheral Europe, although that is a label that de Ramon-Laca says does not reflect investors’ view.

“Investors … trade in nuance and can spot an underrated investment when they see one,” he said.

“In 2018, those that have treated Spain as ‘periphery’ have missed out on a relative-value opportunity; our 10-year yield is now much further below Italy than it is above Germany. The market seems to be treating Spain like a semi-core credit, but … the market has moved beyond these simple labels.”

TRANSPARENCY, PREDICTABILITY

Many praise the Tesoro’s transparent and predictable market operations. When it comes to syndication, it uses the so-called early bird approach, whereby investors that submit orders before any indication of price is published obtain more bonds than if they had waited.

“To have a critical mass when you go out with a deal helps with execution risk,” said Alex Barnes, head of SSA syndicate at Citigroup.

“Having achieved this, they want to maintain this. The bookbuilding process for a sovereign can be complex but Spain is keen to be fair. They’ve been through the sovereign crisis and understand that times can get tough.”

Spanish bonds also offer value when so little can be found in an ECB-dominated world.

“The main factor behind Spain’s success in the bond market this year is that our bonds offer strong value given their rating, which is clearly on its way up,” said de Ramon-Laca.

This has allowed the Tesoro to tackle some trickier projects such as the €6bn 30-year for which it received over €26.2bn of demand in a year when duration has been a less prominent theme.

“Spain has managed to extend duration, which is particularly important when, as an issuer, you have a large amount of funding to do,” said Myriam Zapata, a director in the SSA DCM team at Credit Agricole. “It’s what the taxpayer wants.”

Its €4bn 15-year inflation-linked issue that came in September was its longest in the format yet.

“Spain is always trying to push the boundaries,” said Zapata.

“The 15-year linker was impressive given that Spain is still a newby in that market – they only started issuing linkers recently.”

Spain brought its first linker in May 2014 and has since issued €22.5bn via syndications in the format.

TOP OF THE CLASS

Spain has also proven a good student when it comes to paying back its European Stability Mechanism loans. A €3bn voluntary repayment in September was the ninth by the country, taking Spain’s outstanding debt to ESM down to €23.7bn from €41.3bn.

The Spanish Tesoro has also made the most of the good times under the European Central Bank’s Asset Purchase Programme. From a 4.07% average, its cost of debt has gone down to 2.47% while the average maturity has gone up from 6.2 years in 2013 to 7.5 years.

De Ramon-Laca therefore expects the transition to a non-ECB buying world to be smooth.

“We expect the impact of the end of net purchases to be limited,” he said.

“The reduction of net purchases has been done in a gradual fashion and disruption so far has been minimal. We are convinced that, as the Eurosystem gradually bows out of the Spanish debt market, other investors will gradually pour in.”