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Spain Bond Sale Tests Demand After Irish Bailout: Euro Credit

Elena Salgado, Spain's finance minister. Photographer: Denis Doyle/Bloomberg
Elena Salgado, Spain's finance minister. Photographer: Denis Doyle/Bloomberg

Dec. 2 (Bloomberg) -- Spain tested investor sentiment with the first debt sale since its 10-year bond yield rose to the highest in a decade following the bailout of Ireland.

Spain sold 2.5 billion euros ($3.3 billion) of three-year debt today, pricing the securities to yield 3.72 percent, 23 basis points less than the same bonds in the market prior to the auction. Spanish bonds extended gains after the sale, and the yield premiums on Spanish, Italian and Portuguese debt over German bunds all narrowed further on the result.

“The average yield at the auction is way below secondary markets,” said Chiara Cremonesi, a London-based analyst with UniCredit SpA. “Taking into consideration the current environment, the auction was decently received and sends a reassuring message to investors, after the recent speculation on contagion of the sovereign debt crisis to Spain.”

The extra yield investors demand to hold Spain’s 10-year debt over German bunds climbed to a euro-era high on Nov. 30 as Ireland’s bailout fueled speculation Spain or Portugal may be next to seek aid from the European Union. The spread is driving up costs for Spain just as its banks reduce debt purchases and the country’s bond redemptions are set to rise next year. The risk for Europe is that a rescue for Spain, an economy almost twice the combined size of Greece, Portugal and Ireland, would strain the region’s 750 billion-euro bailout facility.

Investors ordered 2.27 times the amount of the bonds offered today, more than the 2.16 times at the previous auction on Oct. 7. The yield on Spain’s three-year bond in the secondary market fell 19 basis points to 3.785, the lowest since Nov. 24.

Sovereign Northern Rock

“With its refinancing requirement being acute early next year, it’s very important that sentiment is positive enough for Spain to access the market or the country will become a sovereign equivalent of Northern Rock,” John Anderson, the London-based head of credit at Gartmore Investment Management Ltd., said before the sale, referring to the U.K. bank that was nationalized in 2008.

Spain has about 45 billion euros of bonds coming due next year, up from 32 billion euros in 2010, according to the Treasury. The first payment of 15.5 billion euros is in April. Spanish banks have about 85 billion euros to refinance in 2011, and about 10 percent of the lenders’ outstanding debt matures in the first half of 2011, Bank of Spain data show.

Bank Holdings

“The pressure on Spain is likely to intensify into next year as refinancing pressures peak in March-April,” Nikolaos Panigirtzoglou, a London-based strategist at JPMorgan Chase & Co., wrote in a research note to clients. “Spanish banks are facing a heavy refinancing hurdle in 2011 themselves, so it would be very difficult for them to fund further Spanish government bond purchases” without financing them via the European Central Bank, he wrote.

Spanish banks hold about 26 percent of the state’s outstanding debt, with non-residents holding 48 percent and Spanish pension funds, insurers and the social security surplus fund holding most of the rest, Treasury figures show. Spanish banks have cut their holdings from 33 percent at the end of 2009, the data show.

Barclays Capital analysts Simon Samuels and Mike Harrison estimate that Spain’s government and banks will seek to raise 73 billion euros in the first four months of 2011. Markets treat the two “as one” after Ireland’s bailout, the London-based analysts said in a Nov. 26 report.

“March and April will be key months for Spain,” said Mohit Kumar, a fixed-income strategist at Deutsche Bank in London. “Things will have to get sorted in the first quarter to reduce systemic risks. If sentiment doesn’t improve and investors stay away from the market, it would be tough even for a country with relatively solid fundamentals.”

Yield Premium

Spain’s benchmark 10-year bond had its biggest one-day drop since the euro’s inception in 1999 on Nov. 29 as the Irish bailout overshadowed Prime Minister Jose Luis Rodriguez Zapatero’s progress in cutting the region’s third-largest budget deficit. The yield on the 10-year bond fell 9 basis points to 5.252 percent after a 23 basis-point drop yesterday.

The yield premium over Germany had risen almost 150 basis points to a euro-area record 298 in the preceding month as Ireland’s woes prompted investors to shun bonds of so-called peripheral countries. That spread narrowed 14 basis points today to 236.4.

Spain stepped up efforts to reduce the deficit and gain investors’ confidence yesterday. The government announced the sale of almost half of its airport operator Aena-Aeropuertos and a 30 percent stake in the state lottery business. Zapatero also told lawmakers a one-time 420 euro-per-month subsidy for unemployed workers will expire in February.

French Auction

Spain was competing for funds with France, which auctioned 5.4 billion euros of seven-, eight- and 15-year bonds today. Portugal’s borrowing costs jumped at an auction yesterday. The country paid an average yield of 5.281 percent on 12-month bills, up from 4.813 percent at a sale on Nov. 17.

Investors have been punishing Europe’s markets since Ireland became the second euro nation after Greece to get a rescue package. Selling extended outside the peripheral markets to Belgium, while the euro fell to a 10-week low versus the dollar on Nov. 30. The euro strengthened for a second day today, to $1.3158, and so-called peripheral bonds gained on speculation the ECB may act to stem the crisis at a meeting today in Frankfurt.

Everything “depends on the ECB,” said Ioannis Sokos, a interest rate strategist at BNP Paribas in London. “If the ECB disappoints, there’s no question of good auction or bad auction, it’s going to collapse afterwards.”

Robust Demand

Carlos Ocana, deputy finance minister with responsibility for the budget, said he was “satisfied” with the auction result. Markets are “volatile,” and “any measure that can stabilize the markets would be welcome,” he said in Madrid today. He declined to comment on whether the ECB should step up bond purchases.

Deputy finance minister for the economy, Jose Manuel Campa, said Nov. 30 demand for Spanish debt has been “very good,” leaving the Treasury in a “comfortable” position. Unlike Ireland before its rescue, Spain hasn’t canceled any scheduled bond sales.

Deutsche Bank AG Chief Executive Officer Josef Ackermann supported Spain on Nov. 30, saying “mistrust” isn’t justified and the country “can deal with its problems itself.”

The government, which has ruled out a bailout, says debt redemptions coincide with periods when most taxes are collected. Campa said the government can’t mold its policy around short-term market moves and current prices “aren’t directly related to the fundamentals” of the Spanish economy.

“Whether Spain’s fundamentals are better than those of Portugal is perhaps academic and irrelevant at this point,” Gartmore’s Anderson said. “The market is fear driven.”

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

To contact the editor responsible for this story: John Fraher at jfraher@bloomberg.net

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