As FT Alphaville has pointed out, some strange distortions are emerging in the trading of Spanish Instituto Credito Oficiale (ICO) debt.
On Friday, for example, ICO paper — which carries the full and explicit guarantee of the Kingdom of Spain — was trading at the same rate as comparable Santander-issued covered bonds (+73 bps over the mid-swap, according to Barclays Capital).
This is not normal. That government guarantee means the paper should, we are told, be more expensive than non-guaranteed institutions like Santander.
One explanation for the distortion provided to FT Alphaville is that SSA issuers are suffering on concerns they might be used as part Eurozone bailout plans.
As Reuters reported last week, Germany’s own equivalent agency KfW was pitched in a bailout option for Greece:
BERLIN, Feb 11 (Reuters) – Germany’s ruling coalition is considering using state-owned development bank KfW to buy Greek government bonds to ease Greece’s financing problems, a senior finance source inside the coalition told Reuters on Thursday. Speaking under condition of anonymity, the source with knowledge of the discussions within the coalition said one plan involved using the KfW to issue a bond, the proceeds from which would be used to purchase Greek debt.
The thing is, KfW spreads versus bunds have remained tight.
One explanation why ICO spreads have not might instead be related to the agency underestimating its 2010 funding needs, we are told.
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A bit of background on ICO comes in handy at this point:
The agency stepped in to support the Spanish lending sector significantly over 2008 and 2009. Among other things ICO, which traditionally focused on providing and supporting private financing to small- and medium-sized businesses, also began supporting Spain’s covered bond market in April 2008 with a €3bn fund generated in response to the crisis.
As the press release stated at the time:
The initiative is directed at banks, savings banks and credit cooperatives, along with branches opened in Spain by foreign credit institutions under the supervision of the Bank of Spain.
The participating institutions undertake to reinvest the full amount of the funds obtained from the sale of the guaranteed tranche in the financing of new Officially-sponsored Housing in the form of new loans granted both to private individuals and to promoters and builders.
Through the facility, ICO guarantees solely those tranches of Asset Securitisation Funds which have Triple-A credit rating prior to the awarding of the guarantee and include mortgage loans (at least 80 percent) to enable private individuals to acquire an officially-sponsored home.
With the facility, ICO is seeking to set up new ways to finance and promote Officially-sponsored Housing by fostering the granting of new loans while adding to its traditional task of financing VPO for rent.
In a more recent investor presentation ICO stated it was also fighting “the consequences of the crisis on disadvantaged groups” with the creation of new loan facilities in 2009 covering ICO Liquidity, ICO-Mortgage deferral, ICO-SME mortgage deferral and ICO-Housing.
Increased activities all round, then.
In fact, according to its latest investor newsletter, ICO’s balance sheet has nearly doubled in the last three years to €60bn.
All that activity naturally has to be funded– and ICO’s preferred option has always been going to debt markets. As the agency stated in the same report:
In recent years, ICO has increased its funding resources so as to cope with the sharp rise in its activity. The Funding Programme for 2009 was €14,000m, and the preliminary target for 2010 stands at €15,000-18.000m range.
Its current projected funding schedule hence looks something like this:
And unlike a more cash-rich corporate it can’t really afford to postpone when markets turn choppy.
On February 3 , for instance, Bloomberg reported ICO was forced to offer investors a 65-basis point premium over the benchmark rate to get €1bn worth of 3.25 per cent paper under way in difficult market conditions. As the wire stated (emphasis FT Alphaville’s):
Feb. 3 (Bloomberg) — Instituto de Credito Oficial, a Spanish government agency that lends to businesses, increased the yield on its 1 billion-euro ($1.4 billion) bond sale as the cost to insure Spain from default surged to an 11-month high.
Madrid-based ICO offered investors a 65 basis-point premium over the benchmark swap rate to buy the 3.25 percent notes, according to data compiled by Bloomberg.
That compares with a spread in the “low 50” basis-point area offered to bond buyers yesterday, according to a banker with knowledge of the transaction who declined to be identified because the information is private.
A basis point is 0.01 percentage point. ICO marketed the deal as Spain’s government seeks to pull the country out of the deepest recession in 60 years. The nation’s unemployment level rose to the highest in more than a decade in January as the country cancels public-works projects to save money. Spain went from a record budget surplus equal to 2 percent of gross domestic product in 2006 to a deficit equal to 11.4 percent last year, according to the European Commission.
“Spain is under pressure to cut its deficit as soon as possible and the evolution of the ICO deal shows that,” said Ivan Comerma, head of capital markets at Banc International- Banca Mora in Andorra, who was invited to buy the bonds. An ICO official in Madrid declined to comment.
Granted the timing was bad. But the point is the paper still hasn’t settled. Here, meanwhile, is an indication of the rate of lending ICO might have to support in 2010 if 2008 accounts are anything to go by:
And as ICO itself stated regarding its lending activities in 2009 (emphasis ours):
In 2009, loans distributed through private credit institutions, mainly to SME, went up by 50%: €15,000m were distributed to over 360,000 enterprises. Summing up, ICO brokered 25% of loans granted in the Spanish financial system in 2009, reflecting the strength of our countercyclical approach in such a difficult year.
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Funds distributed by ICO to both small and large companies amounted to €18,000m. Considering that the private system’s credit variation was negative (- 1.7% y/y as at Nov. 2009), we can state that ICO was the benchmark credit institution in lending to companies.
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Our plans succeeded, despite a year of much uncertainty and volatility on the markets. Lastly, some of our year-end indicators reflect ICO’s continued solvency level despite an intense pace of investment. The BIS ratio was 11.61 with a Pre- Tax Income of € 30.26m.The default rate was 2.89 as against a credit sector average of 4.99 in October.
No surprise then it’s been going to market in as many currencies as it can (ELEVEN no less: EUR, USD, GBP, NOK, AUD, JPY, SEK, BRL, CHF, NZD, TRY).
Unlike Greece, the agency is at least supposed to be a prudent and neutral hedger. As the agency emphasised in January (emphasis ours):
As more of ICO´s lending activity is carried out in EUR, most of our issues are swapped back into this currency so as to avoid interest and exchange rate risks.
Related links:
Spain’s ICO distortion - FT Alphaville
Next up for Europe, covered bond catastrophe? – FT Alphaville