Sunday, 20 January 2019

Exit, pursued by bulls

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  • Exit, pursued by bulls

If the reaction of the debt markets is anything to go by, both Spain and Portugal are well on the road to recovery, as investors swamp new issues and yields drop drastically.

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Barely an eyebrow of protest was raised as Portugal streamlined its economy in the aftermath of the eurozone crisis. The country has been able to privatise its airport management company, a motorway operator and the national postal service with barely a murmur. An estimated US$11bn of assets have been sold, according to government figures. These were just part of the conditions of the €78bn loan the country received from the Troika of the European Union, European Central Bank and International Monetary Fund in 2011.

But when the government, under centre-right leader Passos Coelho, announced its intentions to sell its collection of works by the Catalan artist Joan Miro there was an outcry. The planned auction in London in February had to be put on hold.

Although the paintings are currently in legal limbo, it is possible that Portugal may not have to sell any more of the family jewels. The country plans to exit its EU bailout programme in June.

There is no doubt that things are looking up. At the end of March, the country’s central bank raised its outlook for the country’s economy for the next few years. The Bank of Portugal expects growth of 1.2% this year, 1.4% next year and 1.7% in 2016. So bullish is the international community, in fact, that the OECD believes that reforms in the country could deliver growth of 3.5% by 2020.

Export growth is in rude health. It will be 5.3% this year after 6.1% growth in 2013. On top of this, the current account has moved from a deficit of more than 10% of GDP in 2010 to a surplus of 0.5% last year. Even unemployment, the Achilles heel of the more troubled Eurozone countries, was down from its peak of 17.7% in the first quarter last year to 15.3% in the fourth.

“Portugal has achieved all necessary reforms that were demanded by the Troika. Portugal is developing exports, it is lowering cost of salaries, and investment is growing. It has managed its deficit. Debt remains high, but this will start to come down,” said Zeina Bignier, deputy head of DCM origination and head of SSA at Societe Generale.

No safety net

What is impressive is not just that Portugal plans to exit the bailout and regain full market access, but that it intends to do so without a safety net. “Insurance is sometimes good but has costs, and you have to weigh the advantages and the costs,” said Bruno Macaes, Portugal’s Secretary of State for European affairs. These intentions are supported by Portugal’s European allies.

“I completely understand it when the Portuguese prime minister says he will take the decision when it needs to be taken and Germany will support any decision. We have stood by Portugal and we will continue to do so,” said German Chancellor Angela Merkel at a joint news conference with the Portuguese prime minister in Berlin in March.

As importantly, Portugal’s plans to go it alone are also supported by the markets.

“Until a year ago, it was commonly thought that Portugal might have to take another full bailout package, but now there is a realistic possibility that it can emulate Ireland’s clean break,” Cantor Fitzgerald wrote in a recent note, referring to Ireland’s smooth exit from its bailout programme in December last year. So taken for granted is Portugal’s departure from the bailout that banking wags have started to begin to refer to the process as “going green” in reference to the Irish precedent.

What had convinced investors is the success of the two bond issues that Portugal sold earlier this year. At the beginning of January, it sold a €3.25bn tap of its 4.75% June 2019 thanks to more than €11bn of orders. In mid-February, it raised €3bn via a tap of its 5.65% February 2024. As before, the deal was priced tightly and with final books reaching €9.8bn.

But what really stands out is the shift that was seen in the nature of the book. Gone was the fast money, and in were the more thoughtful investors. For the first deal, a significant 16.4% came from Scandinavia and Germany, Austria and Switzerland. More to the point, hedge funds took only 7%, the majority going to asset managers and pension funds. By the second deal a third of the investors were those traditionally regarded as cautious, while only 4% went to hedge funds.

“Real-money accounts have come back to Italy, Spain, Ireland and Portugal. And real-money accounts that can’t go back to Portugal yet, because of the rating, are looking closely,” said Florian Weber, rates strategist at Credit Suisse in London.

Restrained by ratings

But there is one major fly in the ointment: ratings. At the moment Portugal is rated Ba3/BB/BB+, in other words distinctly non-investment grade by all three ratings agencies.

“You could argue that none of the peripheral European credits have yet received the full recognition they deserve for the difficult and fundamental economic reforms that they successfully implemented,” said Lee Cumbes, head of European SSA DCM at Barclays. He points out that the last rating from Moody’s was a pretty brutal three-notch downgrade.

There is a sense that a corner has been turned.

“The broad-based downgrade of sovereign Europe has ended. The key assumptions that led to those downgrades have changed massively,” said David Schnautz, director, interest rate strategy at Commerzbank.

This is certainly the case for Portugal. At the moment, it has sold €6.25bn of the €11bn–€13bn target it had set itself for this year. This year’s needs are fully funded and the country has already made a €3bn dent in its €16bn funding needs for 2015.

So what are the next steps for Portugal? The path is pretty clear.

“There is a step-by-step process of going back to the market,” said Credit Suisse’s Weber. “First of all to tap outstanding bonds to a real size to get good liquidity, then to move to syndication and then to paper auctions. It was a similar story with Ireland.”

Few now doubt that Portugal could go it alone. At the beginning of April the sovereign’s 10-year paper was trading at 3.92%, a long way away from the nightmare peaks of 17.36% scaled in January 2012. As one trader pointed out: “The market is so relaxed about Portugal – the forward reward is built in.”

The clear aim for the sovereign is to return to regular auctions as soon as possible and it is increasingly likely that Portugal will bypass a new syndicated bond deal before jumping in.

“The fact that there is still appetite for Portuguese bonds and not a lot of sellers out there makes it right to look to start a regular auction process. We don’t need to do very big sizes now. Again, our objective is to continue to pre-fund 2015,” Joao Moreira Rato, chief executive of Portugal debt agency IGCP, told Reuters in early March.

Since then Portugal has announced that it intends to hold either one or two auctions before the summer break, with an expected issuance amount between €500m and €750m.

Back at work

If Portugal is well on the route to recovery, its Iberian colleague Spain appears to have finished convalescence and is starting back at work. Indeed, it is a sign of how well the economy has been performing that the reception of the sovereign’s latest auction, of €5.583bn in April, was apathetic at best. The cover on the €2.727bn five-year portion – the 2.75% April 2019s – was only 1.7:1. The reason for investor indifference was not economic weakness, rather that Spanish yields were at their lowest levels since 2005.

Certainly, at the end of January Spain sold a new €10bn 10-year bond that was so successful that more than 450 investors placed nearly €40bn of orders, with syndicate officials reporting that €22bn of orders were placed in the first 30 minutes of the sale. The deal was later priced with a coupon of 3.8% to yield 3.845%. Since then it has traded in to 3.65%, a yield not seen since Spain was Triple A rated by all three main rating agencies. It is worth remembering that as recently as the summer of 2012 the yield on the sovereign’s 10-year paper was up at 7.6%.

This is not to say that all problems have been resolved. The Bank of Spain might have revised growth forecasts upwards to 1%–1.5% for this year and 1.5%–2% for 2015, and indicators in general might all be positive, but the elephant in the room remains unemployment that reached 26% in the fourth quarter last year.

As one DCM head pointed out: “Spain is still under recovery. The economy still needs to diversify and it is still fragile.” But even if there might still be individual problems to address, there is no doubt that the Iberian peninsula is back.


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