Spain Sells Upper Target at Bond Auction After Moody's Threatens Downgrade

Spain sold 3.5 billion euros ($4.3 billion) of five-year bonds at an auction today, reaching the maximum sale target even as its borrowing costs rose after Moody’s Investors Service said it may cut the country’s top credit rating.

Spain sold the notes at an average yield of 3.657 percent, compared with 3.532 percent at an auction of those bonds on May 6. Demand was 1.7 times the amount sold, below the bid-to-cover ratio of 2.35 at the May sale.

“They did fill it at pretty much the maximum of their guidance, and when you consider the backdrop, you’d have to say that’s encouraging,” said Sean Maloney, a fixed-income strategist at Nomura International Plc in London. The bid-to- cover ratio was “a bit low,” he said.

The sale came hours after Moody’s placed Spain’s Aaa credit ranking on review for a possible downgrade, citing “deteriorating” growth prospects, challenges in meeting deficit targets and the risks posed by higher borrowing costs. Spain, which faces 24.7 billion euros of debt redemptions this month, is trying to convince investors it can cut the euro region’s third-largest deficit, while bolstering the country’s savings banks and lifting the economy out of a two-year slump.

‘Safely Away’

The average yield at the auction was in line with the yield for the same bonds in the market before the sale, and the yield declined after the auction to 3.773 percent from 3.796 yesterday. Spain’s main IBEX-35 share index was 0.7 percent lower as of 2:38 p.m. in Madrid, having fallen as much as 3.1 percent earlier.

“They got it safely away,” said Padhraic Garvey, head of developed-market debt strategy at ING Groep NV in Amsterdam.

“There was a concession running up to the auction,” he said. “Every time there’s an auction, it’s a test and they’ve passed the test.”

The extra interest investors demand to hold Spanish 5-year debt rather than equivalent German bonds declined to 223.8 basis points from 229.5 basis points yesterday. That spread narrowed for the first time in three days yesterday as a European Central Bank tender signaled the euro region’s banks are in less need of cash than investors had estimated.

Investor Sentiment

The Spanish auction provides a test of investor sentiment toward the euro area’s fourth-largest economy, and the Moody’s decision may add to pressure on the Socialist government to deepen spending cuts as it starts drafting next year’s budget. Fitch Ratings and Standard & Poor’s already stripped Spain of their top ratings.

Moody’s also cut the ratings of five Spanish regional governments, saying a decline in tax revenue would lead to an increase in indebtedness. Prime Minister Jose Luis Rodriguez Zapatero declined to comment on Moody’s threat to cut Spain’s credit rating today, saying only he is “fully confident in the strength of the solvency” of Spain.

The government has pledged to cut the deficit to 6 percent of gross domestic product next year from 11.2 percent in 2009, aiming to bring the shortfall in line with the European Union limit of 3 percent in 2013. Moody’s said the deficit will remain “just over” 5 percent that year, lead Spain analyst Kathrin Muehlbronner said in a telephone interview yesterday.

Spain’s Deputy Finance Minister Jose Manuel Campa said the timing of the Moody’s announcement was “unfortunate.”

“Many of these downgrades come on the evaluation of long- term growth, but the timing tends to be linked to short-term volatility,” he said in an interview in New York.

Debt Redemptions

The Moody’s announcement boosted Spanish financing costs in a month when it faces the largest debt redemptions for the rest of the year. The government has said it will have no trouble paying the maturing bonds, whose expiry coincides with a period of peak tax collection. The Treasury has scheduled three more auctions of bonds and bills before the end of the month.

While Spain’s deficit last year was 11.2 percent of GDP, its public debt was 53 percent of GDP, lower than in Germany, and less than the euro-region average of 79 percent. Spain sees that ratio rising to 74 percent in 2012. Standard & Poor’s ranks Spain AA, and Fitch Ratings cut Spain to AA+ on May 28, citing concerns over the growth outlook.

Moody’s also forecasts slower economic growth than Spain’s Finance Ministry as budget cuts threaten the recovery. It projects that the economy will expand by an average 1 percent a year through 2014, while the government sees growth accelerating to 2.7 percent in 2013.

Campa said in the interview yesterday that growth next year may be “slightly less” than the 1.3 percent the government now expects.

To contact the reporter on this story: Emma Ross-Thomas in Madrid at erossthomas@bloomberg.net

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