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Capital Markets Weekly: Italy and Spain set new demand records within sharply-growing sovereign issuance

24 April 2020 Brian Lawson

Overview

This week's most dramatic developments were from Italy and Spain, with Italy gaining over EUR110 billion in demand on 21 April - by an ample margin, the largest-ever order book for a sovereign syndicated sale - for a EUR16 billion offering of five-year and 2050 debt, while Spain captured EUR97 billion for its EUR15 billion 10 year sale the following day - the largest book for a single tranche sale.

Additionally, Luxembourg gained over EUR9 billion for a EUR2.5 billion sale of five and ten-year bonds, while Estonia reportedly is planning its first public bond sale for 18 years, and to expand its debt stock substantially. In Emerging Markets, both Mexico and Guatemala have issued successfully despite recent downgrades. The US junk bond market issuance also has been very active including a USD8 billion heavily oversubscribed sale by Ford.

Italy/ Spain

Italy's record EUR110+ billion book on 21 April was for the sale of a new July 2025 bond and tap of its 2.45% September 2050 deal. On 14 April Italy had issued revised guidance for its 2020 issuance, noting that its increased funding needs drive it to consider additional syndicated deals, including offerings for under ten years, previously sold by auction. It promised a revised projected funding volume shortly.

On 22April, Spain gained EUR97 billion for a EUR15 billion 10-year syndicated sale, priced at 17 basis points over its outstanding 2030 bond. The deal gained support from 560 investors, with 79% distributed outside Spain. Spain's prior record was EUR53 billion of demand or its 10-year sale this January.

Estonia/ Luxembourg/ Other SSA

According to International Financing Review, Estonia mandated banks for its first syndicated bond issue in 18 years.

This is exceptional given the country's "conservative fiscal policy…for a long time". At end-2019, its State Treasury Department reported that its only outstandings were two loans from the European Investment Bank and one Treasury bill, covered 1.4 times by a liquidity reserve. Gross government debt was 8.4% of GDP.

Estonia's overall financial position has changed dramatically given the impact of the COVID-19 pandemic. On 13 April Minister of Finance Martin Helme claimed that the "crisis at hand is unprecedented". Prior to offering relief measures, the Ministry of Finance forecast an 8% fall in GDP in 2020. In consequence, it forecast that the general government budget deficit would reach EUR2.62 billion, 10.1% of GDP. Overall, the debt-to-GDP ratio is now forecast to reach 22%.

Luxembourg also issued, placing EUR2.5 billion to fund a new EUR2.5 billion loan guarantee scheme with the package seeking to "unlock the financing capacity needed to help Luxembourg navigate through the COVID19 crisis", according to the Ministry of Finance. It gained demand of over EUR9 billion.

Also on 21 April, a German auction of two-year "Schatz" bonds, priced at -0.68%, gained demand of EUR11.385 billion for the EUR4.085 billion sale, the highest coverage ratio for a German bond auction since 2007 according to Reuters.

Hungary has mandated for six and 12-year Euro-denominated issuance.

Asian Development Bank sold a USD4.5 billion five-year bond to help fund its recently-expanded USD20 billion COVID-19 program: it now plans to raise USD28 billion this year. According to ADB treasurer Pierre Van Peteghem, the order book "is ADB's largest ever recorded", with 130 investors involved.

The UK's Treasury suggests that its 2020-21 financing need could rise by GBP220 billion to GBP382 billion, according to Office for Budget Responsibility illustrative estimates. For the period May-July, it announced plans to raise GBP180 billion from gilt sales, after targeting GBP45 billion in April.

Sub-investment grade debt

On 17 April the Financial Times reported that the average return on sub-investment grade dollar debt had fallen to 7.8%, according to Ice Data Services data. Before the Federal Reserve's extension of its quantitative easing support to sub-investment grade debt it had peaked at over 10 percent during March.

According to EPRF data, US sub-investment grade bond funds enjoyed record inflows of USD10.5 billion in the week to 17 April.

This has translated into rapid further revival of supply, with USD8.5 billion of new dollar-denominated junk debt placed successfully just on Friday 17 April:

Ford

Ford completed a USD8 billion three-tranche bond sale: Reuters sources suggest books reached around USD40 billion. Ford placed USD3.5 billion of three-year bonds at 8.5%, USD3.5 billion for five years at 9% and USD1 billion for 10-years at 9.625%: initial guidance on the longer-dated tranche offered returns of 11% area. By contrast, Ford paid 3.5% for five-year issuance in January 2020.

The bonds are eligible for the Federal Reserve's asset purchase scheme, as Ford retained investment grade ratings on the Fed's reference date of 22 March. The company recently drew almost USD16 billion in bank lines and the latest borrowings increase its cash balances, giving it greater resilience to face negative cash flow during the COVID-19 pandemic.

AMC Entertainment

Also in the market was AMC Entertainment, the world's largest cinema chain. The company, which is reportedly facing acute financial strain, raised USD500 million for five priced to yield 11.03%.

With the company's European cinemas largely closed due to lockdown measures, and nationwide closure in the US, the company is widely described as facing significant risk of bankruptcy. Its USD600 million 5.75% June 2025 bond fell from a price of over 90 percent of nominal value in February to just 31% on 17 April, according to media reports. Moreover, a New York Post report previously claimed it had hired legal advisers to consider Chapter 11 filing for bankruptcy protection.

Emerging markets

Guatemala followed recent successful issuance by Panama and Peru by raising USD1.2 billion in a two-tranche operation. It placed USD500 million of 12-year social bonds priced at 5.375%, 50 basis points inside initial guidance, and raised USD700 million through a tap of its 6.125% 2050 bond, again pricing 50 basis points tighter than initial price talk. Demand reached roughly USD8 billion. The country was recently downgraded by Fitch to BB-, but benefits from its low debt stock, reported at just under 25% in 2018.

Mexico followed it on 22 April: despite recent downgrades, it gained USD28.5 billion of demand for a USD6 billion sale of five, 22 and 31-year notes, with record demand for the longer-dated tranches (each sized at USD2.5 billion). The three tranches were priced at 4.125%, 5% and 5.5% respectively.

Implications and outlook

Italy and Spain's exceptional successes are clearly positive indicator of the effectiveness of the European Central Bank's quantitative easing backstop. While both offered clear yield pick-up to attract demand, the degree of enthusiasm was highly impressive, showing that investors are giving little focus to strained debt fundamentals, such as Italy's debt to GDP ratio being widely projected reaching over 140% in 2020.

Estonia's debt plans flag the severity of the almost-universal impact of COVID-19 on public finances. While the country easily can access markets, already indicated by improved pricing for a recent 12-month bill sale, it faces unprecedented borrowing needs given the severe projected drop in economic activity.

The record inflows to high-yield bond funds are somewhat surprising given the poor business prospects for many junk issuers. Such flows, the sharp decline in sector yields, and the considerable revival in supply are all positive indicators of the potency of Federal Reserve intervention supporting the segment. Ford's deal is clearly impressive, both for its size and the volume of demand achieved, while the positive change in sentiment is perhaps better illustrated by AMC Entertainment being able to fund despite its widely reported financial stress.

Posted 24 April 2020 by Brian Lawson, Senior Economic and Financial Consultant, Country Risk, IHS Markit

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