How much do you want to know about eurozone bond auctions?
How much do you really want to know about eurozone bond auctions?
Given what we’d suggest is a highly premature rapturous reaction to Portuguese and Spanish sales of debt last week, here’s something that might help illuminate the wider processes, and risks, of eurozone debt issuance. (Of course, asset risk is something else entirely).
In a note on Friday, Marc Ostwald of Monument Securities performed an invaluable service in explaining at length that you can’t really look at a set of auctions across the eurozone and conclude everything is improving (nor equally, that everything is going to pot).
You have to look for national context, he argues:
With so much market and media focus on the success and failure of Euro area auctions, there appears to be not inconsiderable confusion about the various processes attached to debt sales in the region, especially the metrics that are being utilized to judge the relative successes and failure. So here is a brief guide from our perspective…
Which we think is highly useful right now, as it particularly illustrates significantly different national and historical priorities in the way that government debt is financed in the eurozone. Or as Ostwald puts it:
As a general point, it should be noted that in many cases, the peculiarities of a given bond auction process are steeped in national methodologies, which were in many cases established long before the Euro was even dreamt of and, as budgets are national (i.e.) sovereign decisions, there has never been any cause, let alone attempt, to create… unitary, more comparable procedures across the Euro area…
Why does this matter?
Well, first consider issues of eurozone government bonds after 2013. These bonds will all bear collective action clauses that would allow an easier process for forcing bondholders to take haircuts on their value, making sovereign debt restructuring feasible alongside bailouts — an objective of the new, post-2013, European Stabilisation Mechanism.
This common legal framework — de facto eurobonds, you might say — presents a complication for these national methodologies, requiring peripheral debt offices in particular to manage these embedded credit risks by altering what types of debt they sell, what maturity, et cetera.
Second, consider what might happen as part of the new debate on the role of the European Financial Stability Facility. Wolfgang Munchau’s column on Monday makes clear that even a very few technical changes to the EFSF’s role, such as pooling or guaranteeing sales of sovereign bonds by peripheral countries, would effectively create the eurozone’s first central debt management office. Again, national methodologies of selling debt would uneasily co-exist with this kind of arrangement. We have a preview already, with the EFSF’s current bond sales to finance Ireland’s bailout loans, which have seen strong investor demand.
So what are those national pecularities?
In particular, there are some key differences in which countries target ‘benchmark’ bond sales in order to make sure their debt stocks are up-to-date and liquid. There are other distinctions as to which countries use syndication (they get a group of banks to corral bidders for auctions); and which countries are aiming to diversify their funding sources.
And there’s an interesting split, as you might guess.
Let’s start with some core (and semi-core) credits.
– A German auction, for example, will always be ‘covered’ because any residual amount not sold to the Street is bought up by the Bundesbank on behalf of the debt office. The central bank then utilises these reserves for the purposes of market operations, including dealing with issues which have gone special. This is why is it’s conventional to look to the ‘real’ bid to cover ratio — the total bids relative to the total volume to the street — to assess an auction’s success. And this itself can go uncovered.
Furthermore, unlike the UK Debt management office, the German debt office tends not to re-open off-the-run issues.
Similar to Germany, but with more syndication: Austria.
– France also focuses on creating new benchmarks of sufficient market size and liquidity each year, but will also attempt to revive selected off-the-run issues among these sales by matching maturities and terms. Hence, maturities on offer considerably vary within even single auctions. There is very occasional syndication in very long-dated bonds.
Similar to France: Belgium.
– Italy, like France, tries to build up benchmark issues and varies maturities within auctions quite a bit. Some quirks though: initial auctions often get followed by a second, top-up, sale of around 10 per cent of issuance to market-makers. Italy is also quite ready to tap international bond markets ad hoc, such as by issuing medium-term notes.
But now let’s move on to Spain and Portugal, where it pays to quote Ostwald more directly. It’s worth noting that Spain has moved from quarterly to monthly announcements of auctions this year in order to manage volatile markets more effectively, although (in common with core sovereigns like France) actual numbers on issuance are released days before each sale. Spain also employs syndication for key 10-year benchmark sales.
But it’s also clear from Ostwald that Spain can tap into some funding diversification if required, and which you’d have to watch if markets become stroppy again (link ours):
Other funding sources:
*Tesoro Publico is open to additional foreign currency issuance
*Floating rate notes have provided in 2009 and 2010 an additional funding source
Projects for future issuance
*European inflation-linked issues (HICP-ex tobacco)
As we noted with Portugal’s recent and unusual private placement of euro medium-term notes, you can look at this development one of two ways — either as a sign of good and resourceful debt management, or something that could fragment Spain’s market if it becomes used too much. It depends less on how individual auctions go, but more on wider metrics of Spanish government debt (benchmarks issued, average maturity of debt, sustainability of overall yields being paid, contingent liabilities from the banks, types of investor, etcetera).
Meanwhile, it’s highly worth noting these points on Portuguese bond sales given how the most recent auction has been hailed as a turning point not just for Portugal, but the entire euro crisis. Says Ostwald (emphasis ours):
Portugal – the auction process and the details provided ahead and after bond sales is broadly similar to Spain, but with Portugal perceived to be a blade of grass away from a rescue package, the vicissitudes of ECB bond buying to offset market maker concession building ahead of auctions are rather more relevant than the procedural elements. Perhaps the more important point to note is that the sellers of Portuguese debt over the last couple of months have been rather less those who are termed by irate local, German & French Finance Ministry officials as ‘evil’ speculators, and rather more those whose risk depts no longer deem Portuguese govt debt to fit the profile of relative stability which is associated with govt debt. The buyers at auctions on the other hand are “reaching” for yield, given the low/no yield available in the G7 safe havens.
We’ve noted this kind of yield-chasing in peripheral sovereign bonds before. It’s not proven particularly stable (Irish bonds were a hot tip shortly before the country veered into extreme crisis in November), especially when carry trades have been involved.
And which type of investor do you think is going to prove more sustainable for Portugal in the long run?
Finally, we’ll close with this reminder from Marc (emphasis ours):
But perhaps the most important point to note for those market participants that are not involved directly with govt bonds is that issues, such as cover ratios are actually only important in Anglo-Saxon markets (i.e. UK and USA), and that an obsession with comparing results that are in essence non-homogenous (except for those obsessed with creating protocol-style boxes for reasons that are frequently “agenda driven”), is that it is the underlying trend in yields, the profile of distribution (frequently not information that is available in the public domain), the brutality (or lack thereof) of the concession building by markets ahead of any form of sale of debt (tap, auction, syndication, even private placement) which is in reality critical to any analysis. The rest of the details are flotsam and jetsam that will only be recalled for a passing moment at the next sale, and then only for the purpose of hyperbole and melodrama.
Full bond auction tour in the usual place.
By Joseph Cotterill and Izabella Kaminska
Frozen in the Greek repo market – FT Alphaville
A loser’s nightmare in Europe’s debt auctions – FT Alphaville
Issuance strategy 2011 – Spanish Tesoro
Sovereigns snare Schuldschein investors – EuroWeek (2009)