Orders for the Kingdom of Spain’s first 2021 syndication fell by a jaw-dropping €75bn last week after the sovereign squeezed pricing to such an extent that little to no value was left on the table.
Until the final terms were announced, the €10bn 10-year looked like it would follow the same script as most SSA deals of the last nine months: astonishing levels of oversubscription.
Books hit over €130bn, a record for the issuer, following IoIs of more than €88bn at the first update for the April 2031s via BBVA, Citigroup, HSBC, JP Morgan, Santander and Societe Generale. But in an unexpected twist – and what looked initially like a typo – books closed at "just" €55bn as investors walked away from a suddenly tightly priced deal.
As the European Central Bank has unleashed liquidity to try and stem the fallout from the Covid-19 crisis, the desperation for assets has grown, with the primary market providing a rare way for investors to pick up a modicum of spread. That desperation has, however, led to order books getting bigger and bigger.
"You have accounts who put in orders for 20%, 30% of the deal size; we know these orders are not rational," a banker said. "It’s not what they want and if they have a bit of a doubt, that would explain why they got cold feet. It might be hedge funds, bank trading accounts, those who were hoping to pass the bonds on quickly.”
While shedding orders is not unheard of for sovereign syndications when pricing is tightened, the SSA market had never seen a drop of such magnitude.
"We had a decision to make: have a high quality order of €55bn with a tight price or a strong headline order book at €130bn with an additional concession," said Pablo de Ramon-Laca, director general of the treasury and financial policy for Spain.
"In the end, we obtained an exceptional result. We're in very different market conditions compared to last year when we did our seven-year in March, for example, and were maybe less sensitive to the last basis point. We are getting back to more normal conditions and with that we have to get used to the size of the order book to be significantly altered during the price-discovery process."
Still, while the drop in orders was significant, the book was still the third largest gathered by Spain for a syndication – and a result that would have been considered an excellent outcome less than two years ago, especially given the tight print.
At 4bp over Spain's October 2030 – 4bp tighter than the 8bp area initial price thoughts – the notes offered 1bp of concession at most, with some bankers saying the deal was in fact 1bp through fair value – a far cry from the 12bp offered on Spain's record breaking €15bn 10-year in April.
"My job is to obtain value for the Spanish taxpayer, place the bonds with high quality investors and make it as smooth a transaction as possible," de Ramon-Laca said. "Because of the exceptional market conditions, we were able to extract a smaller premium on behalf of the taxpayer. 4bp was too tight for some investors, predominantly faster money ones that are focused on harvesting new issue concessions in primary."
Still, some bankers away from the deal were critical of the execution.
"If you put out a bit of a NIP, then there are good trades to be done – just look at EFSF, Belgium, EIB. But if you push too hard, it becomes ugly, things become more difficult," a second banker said, adding that he did not think that the deal would perform. "I don’t think you can do €10bn in good conditions with a €55bn book."
The bonds were quoted just over 1bp wider a day after pricing, though the leads said political noise coming out of Italy was to blame rather than the execution.
Another banker called the execution "shambolic". “You could argue that they were too cheap to start and too expensive at the end. They pushed too far; you’re not moving from 100bp to 104bp, you’re going from 8bp to 4bp; they should have been more thoughtful around execution,” he said.
Whatever the truth, the deal’s execution throws into sharp relief the challenges faced by the SSA sector. Investors across the board are fighting for allocations in primary where issuers typically offer new issue concessions as secondary offers have dried up, with the price-insensitive ECB buying up paper in secondary.
“Last year, investors benefited from the elevated concession levels that were required to fund the sudden increased borrowing needed to finance the sovereign response to the Covid pandemic,” said Alex Barnes, head of SSA syndicate at Citigroup. “We’re basically back to pre-Covid concessions though now, which are much smaller, and in this case, just 1bp.”
In the case of Spain, its early bird strategy, which sees investors put orders in before they know what the guidance will be, could have played a part as well.
"The book was €88bn before we put out any price guidance and I think many investors came into the book early with vivid memories of the double-digit concessions which sovereigns were paying last year,” said Philip Brown, a managing director in the DCM team at Citigroup.
“But I think the message from Spain was clear: don’t expect us to pay a big concession, we’re back to business as usual. More broadly, I wonder if we will see the same scale of frothy, exaggerated oversubscription in order books in 2021 as we saw last year, given the very different bond market conditions today.”
Price sensitivity was also in evidence in the case of L-Bank’s €1bn 10-year that failed to cross the line with books over €800m at the last update.
For de Ramon-Laca, it is a shot across the bows of investors who may not be as essential to order books are they think they are.
“One some occasions, DMOs can be intimidated by hedge funds but we have to be prepared to see books fluctuate,” he said. “We were confident we could place €10bn solidly to a high-quality and diverse investor base."