European Sovereigns Are Increasing their Borrowing – But at What Cost?

If you thought the Holy Week was boring on fixed income markets, you might be right – but only if you turn a blind eye to the primary markets. Latvia, Slovenia, Ireland and Cyprus decided to ask fixed income investors for money to bridge the GDP gap created by Covid-19 induced recession. How did the borrowing go? Find out in this brief article.

Last week was marked by a number of European countries going to the international markets in order to obtain funding for their fiscal support packages. It’s worth mentioning that even German Finanzagentur decided to go for a syndicated approach to place bonds, a maneuver not used for at least five years. Back in 2015 the Finanzagentur used syndication only to issue unique instrument for that time – a 2.5b EUR inflation-linked paper. German bonds are usually placed through a network of primary dealers, which deprives the issuer of valuable data on who exactly is buying. The next syndicated issuance of German federal bonds will be conducted in May and it’s quite likely that a 15-year paper will be issued. A move toward the syndication and away from primary dealers comes after two successive revisions of borrowing targets: on March 23rd the Finanzagentur raised its borrowing target for 2020 by 119.5b EUR, followed by additional 109.5b EUR on April 07th (total 2020 borrowing costs now amount to 439b EUR). This nugget of information is relevant because it indicates that German Bunds might start losing their scarcity value, despite ECB’s strong bond buying.

Speaking about last week’s issuances, Latvia placed a 1b EUR 3Y paper (LATVIA 0.125 04/14/2023) @ 0.209% YTM (MS+49bps, Bund+86.3bps), with orderbook reaching merely 1.35b EUR (1.35x bid-to-cover). Latvian issuances are usually small in size, as well as illiquid, meaning that a lot of investors shun Baltic state since at these times liquidity is king. It’s quite interesting that fund managers took about 46% of the total issuance, which is a good sign that asset management is gradually stepping in.

Slovenia pushed for one of the largest issuances this year, a triple tranche valued at 2.25b EUR. The triple tranche included a 3Y tap (0.25% YTM, MS+50bps, Bund+86.9bps; 1.15b EUR with book @ 3.5b EUR, 3.04x bid-to-cover), 10Y new paper (0.906% YTM, MS+85bps, Bund+123.9bps, 1.00b EUR with book @ 3.8b EUR, 3.8x bid-to-cover) and 25Y tap (1.527% YTM, MS+130bps, Bund+156.9bps, 100m EUR with book @ 800b EUR, 8.0x bid-to-cover). Speaking about the 10Y paper, the spread to Bund widened a bit to 129.22bps if you take 100.30 as a clean price, but this spread widening came on the back of wide bid-ask spreads on new Slovenian paper. For the reference, Latvian 2028s are traded at 0.324% YTM (Bund+87.8bps) and in spite of the 2Y shorter maturity the spread between Slovenia and Latvia still appears to be quite wide. It’s also worth mentioning that the most recent IMF’s WEO expects Slovenian and Latvian economies to experience the contraction of roughly the same magnitude (-8.6% YoY in Latvia versus -8.0% YoY in Slovenia, FY2020), however a quicker rebound is expected in Latvia next year (8.3% YoY in Latvia versus 5.4% YoY in Slovenia).

Speaking about other issuances during the Holy Week, Ireland made a huge splash in the global liquidity pool by issuing 6b EUR of 7Y paper @ 0.242% YTM (MS+35bps, Bund+74.2bps, orderbook @ 33b EUR, bid-to-cover 5.5x). Street bids are already down to 0.09% YTM (MS+26.4bps, Bund+70.5bps) and it’s worth mentioning that Ireland has the same rating as Slovenia according to S&P Global Ratings. Nevertheless, thanks to a more diversified economy, a comparison between the two countries is almost impossible in terms of fixed income instruments. Irish splash caused the investors with a sense of disinterest for the Cypriot double-tranche: the 7Y was placed at 1.564% YTM (MS+165, Bund+204bps, 1.25b EUR issuance with a 1.8b book size), while the 30Y paper was placed @ 2.339% YTM (MS+215bps, Bund+225.6bps, 500m EUR issuance versus 775m EUR large book).

One valuable lesson for European EMs could be drawn from Cypriot issuance last week – investors are really sensitive to price guidance and subsequent revisions. The orderbook on Cypriot 7Y shrank by 400m once the country decided to tighten the spread by merely 5bps. Of course other factors must be considered, such as the fact that Cyprus went to the market during heavy issuances.

Bear in mind that all of these countries are eligible for ECB’s bond buying programs. We are still waiting for the first post-pandemic debt issuance placed by EU sovereign outside the euro area. Looking at the fiscal stimulus packages, our waiting might soon come to an end.   

Ivan Dražetić, CFA
Category : Blog

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