Italy Offers Escape From Negative Rates With Floater Yield Floor

  • Finance Minister said Tuesday won't charge notes holders
  • Coupon floor amounts to free option for investors: ING

Italy’s decision to set a floor of zero on the coupon on its floating-rate notes may boost demand for the securities as countries adapt to negative interest rates across the euro area’s sovereign-debt market.

The Rome-based Finance Ministry said Tuesday that coupons on its floating-rate notes cannot be negative, an announcement that may help underpin investors’ demand for a safe option amid a broader negative-rate environment. Coupons on Italy’s floating-rate notes, known as CCTs and CCTeus, are linked to the nation’s six-month Treasury bill yield and six-month Euribor respectively.

“Setting a floor is like giving away an option to investors for free," said Martin van Vliet, senior interest-rate strategist at ING Groep NV in Amsterdam.

The European Central Bank cut its main refinancing rate to zero and lowered the deposit rate to minus 0.4 percent on March 10, leaving open a scenario in which the spread applied to the coupon on floating-rate securities would imply a negative rate, meaning an investor would have to pay interest to the borrower. If this were the case, the Treasury said Tuesday, the securities won’t pay a coupon, but investors won’t be charged.

‘Additional Support’

“The announcement is very much likely to provide additional support for the issuance,” said Matthew Cairns, a strategist at Rabobank International in London. “The floor is in itself a psychological break-even point for investors who may be unwilling to buy the floaters should they end up having to pay for the privilege to do so.”

The six-month euro interbank offered rate, or Euribor, was minus 0.132 percent Wednesday, according to data from the European Money Markets Institute. That compares with minus 0.141 percent on March 10, the lowest reading for the once-a-day fixing since Bloomberg started collecting the data at the end of 1998.

The ECB’s monetary stimulus of rate cuts along with its asset-purchase program has pushed government bond yields in Italy and other euro-area nations to record lows, and in some cases below zero. While the decline in borrowing costs has brought relief to the country’s stretched public finances, it has prompted the nation’s Finance Ministry to deal with the issue of negative rates.

Negative-yielding securities totaled $2.4 trillion of the Bloomberg Eurozone Sovereign Bond Index as of Tuesday. That’s more than one third of the $6.3 trillion total index.

Market Standard

Italy’s decision to introduce a coupon floor is “natural” and it will probably become a standard as euro-region countries move to a negative interest-rate environment, Bank of America Merrill Lynch analyst Alexander Batchvarov said by e-mail, adding that Denmark did something similar.

“It can certainly remove a source of uncertainty,” Chiara Manenti, a fixed-income strategist at Intesa Sanpaolo SpA in Milan, said by phone. “There have been many questions from investors on what would have happened to floaters.”

Italy auctioned three-year notes with a negative yield for the first time earlier this month. The securities due in October 2018 were sold with an average yield of minus 0.05 percent, compared with 7.89 percent for three-year notes at the height of the euro-area debt crisis in Nov. 2011.

Italy sold six-month bills with an average negative yield for the first time in October, when the Treasury allotted the securities at minus 0.055 percent. Still, analysts say it’s unlikely that Italy will have to trigger the coupon floor on floaters in the short term.

The coupon on Italy’s floating-rate note due in December 2022, which pays six-month Euribor plus 70 basis points, is seen remaining well above zero in the near future. “We need at least a couple of more ECB rate cuts” to see negative rates, ING’s van Vliet said.

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