[LONDON] Investor frustration at how expensive euro public-sector debt has become was on display this week, with the Kingdom of Spain receiving a surprisingly tepid response to a 15-year linker and Germany-guaranteed KfW having to switch to US dollar funding.
Spreads have tightened dramatically since the ECB announced its sovereign and sovereign-guaranteed bond purchase programme in late January, a trend that has accelerated since the implementation began earlier this month.
Many buyers seem to have had enough and bonds issued by the Italian sovereign and the European Investment Bank got a muted reception earlier this month.
This lack of enthusiasm was on display this week as well: Spain on Tuesday priced a 3.5 billion euro one per cent November 2030 index-linked bond offering, falling 500 million euro short of the amount it had hoped to raise.
The decision not to go larger was based on the order book of 6.7 billion euro, which was well short of demand seen both for recent Spanish nominal bonds and for Spanish linkers issued in the past. The country's two index-linked notes priced last year both received demand of more than 10 billion euro, while other deals from the country - and from Portugal - received orders of over 20 billion euro.
"Clearly, the spreads and yields are not what they were, and investors have benefited from the rally but do have to ask if the scope for potential performance has diminished," said Alex Barnes, head of SSA fixed-income syndicate at Citigroup, a bookrunner on Spain's latest deal along with Barclays, BNP Paribas, CaixaBank, Credit Agricole CIB and Goldman Sachs.
"Order books in excess of 20 billion euro are remarkable achievements and shouldn't be considered the norm for all periphery syndications. Maybe we all need to bring our feet back down onto the ground and have a balance on what we expect from this sort of transaction in the future," he said.
The peripheral sovereign market has certainly been a particular beneficiary of QE, with investors moving further down the ratings spectrum in search of yield.
But the region sold off recently and continued to underperform this week. Spain's 1.95 per cent July 2030, the reference point for the new linker, was bid at a yield of 1.72 per cent on Tuesday, 18bp higher than the low it reached in the middle of March, according to Tradeweb.
Such is the shift in the market that German agency KfW, Europe's best rated and most liquid agency name, opted to fund in US dollars instead of euros, printing a US$5 billion 1.5 per cent five-year deal on Thursday.
"We did look at the euro market, but we finally decided against a longer-dated trade in euros," said Klaus-Peter Eitel, vice-president, new issues, at KfW.
"After QE, we are in untested waters, and our impression is that even a higher new-issue premium may not guarantee a successful transaction," he said.
The best indication of this was the EIB's 2 billion euro 0.125 per cent April 2025 transaction from the week before.
The deal was priced at 30bp through mid-swaps and, while it was offering a new-issue concession, investors balked at the tight levels against Bunds - around 5bp at the time - and the issuer fell one billion euro short of its usual size for a benchmark transaction.
One lead banker on KfW's US dollar trade suggested that the German agency would have had to offer something like a 10bp new-issue premium to get a euro deal done; uncharted waters for an issuer that tends to price new deals tight against the curve.
Still, the buyside needs to deploy capital somewhere, and newly established Agence France Locale found itself in the right place at the right time.
Despite an Aa2 rating from Moody's with a negative outlook and a 20 per cent risk weighting, the issuer's debut 750 million euro 0.375 per cent seven-year bond offering was swamped with demand from central banks and official institutions that normally tend to buy Triple A paper with zero risk-weighting.
"The deal was extremely well supported by public institutions, much more so than some French agencies in this tenor," said Laurence Ribot, head of covered bond and SSA fixed income syndicate at Natixis, a bookrunner along with HSBC and JP Morgan.
"This has to do with the quality of the credit, but also the fact that it is very hard for those investors to find value in the secondary market," she said.
One thing is clear: these could be delicate times for Europe's core issuers, with the ECB's asset purchase programme set to run up to September 2016 at the very least.
"The euro market is distorted by QE. It's a bit more tricky. We have to gain more experience of how to navigate this market,"said Eitel of KfW.