September 7, 2016
By Abhinav Ramnarayan
LONDON (Reuters) – A push by some euro zone countries to issue debt that won’t need repaying for many decades may come at a price – but for borrowers who lived through the bloc’s 2010-2012 crisis, it’s probably a price worth paying.
France, Belgium and Spain have all sold 50-year bonds this year, locking in record low borrowing rates, and Italy is considering following suit. Ireland and Belgium have even sold 100-year bonds, albeit in relatively small sizes.
Some bankers warn there is a point at which the economics of such transactions may not make sense. They calculate that Italy could save on interest payments if it instead issued 30-year bonds, and returned to the market three decades hence to raise funds for the final 20 years.
But borrowers are also seeking insulation against any future repayment crunch like the euro zone crisis, when some struggled to refinance maturing debt at an affordable price. For them the extra basis points they have to pay on long-term debt is effectively an insurance policy against “rollover risk”.
So far there’s been no shortage of buyers, as short-term debt yields have evaporated and turned negative in many cases due to the European Central Bank’s ever easier policies and bond purchases to stimulate the euro zone economy.
Big institutional investors such as pension and insurance funds have scrambled for long-dated bonds to get some kind of return on their fixed income investments.
In a recent analysis, Deutsche Bank said Italy could pay 2.65 percent annual interest on a 50-year bond, provided it does not have to pay a premium that markets sometimes demand for debut issues.
But, crunching numbers on the alternative, Deutsche reckoned that selling a 30-year bond at 2.2 percent today and then a 20-year bond in 30 years’ time would be likely to work out cheaper for the Italian taxpayer.
The great unknown is how high yields on Italian 20-year bonds will be three decades’ time. Deutsche calculated they would have to be significantly more than double today’s levels of around 1.75 percent <IT20YT=TWEB> even to match the amount of cash the Italian Treasury would pay in coupons over the life of a 50-year bond.
“These numbers imply that if Italy sold a 30-year bond now, and then in 30 years’ time they sold a 20-year bond at a yield of less than 4.5 percent, they would still make a saving compared to if they issued a 50-year bond now,” Deutsche Bank research analyst Abhishek Singhania told Reuters.
“In short, looking purely at the economics of it, doing a 50-year bond right now comes at a cost.”
However, the risk is that the era of cheap debt will be a very distant memory in 2046. Yields on 20-year Italian bonds were last at 4.5 percent only three years ago, and hit 8.2 percent during the crisis in 2011.
CANATTA CONSIDERS
Under its quantitative easing programme, the ECB is buying bonds with maturities of between two and 30 years, depressing their yields. But for bonds outside the scope of its asset purchases, yields tend to increase dramatically past the 30-year point in the euro zone.
Two of Italy’s primary dealers agreed that the cost of issuing a 50-year bond is quite high. One suggested that debt management officials at the treasury, led by Director General Maria Cannata, are grappling with this very issue at the moment.
“I think Ms Cannata is still considering whether or not it is worth it,” the dealer said.
The Italian debt management office did not respond to requests for comment.
In addition to an Italian 50-year issue, Commerzbank analysts expect Spain and Belgium to sell 15-year bonds and France to revive plans for a 30-year inflation-linked bond, either through auctions or syndications.
But there is a danger that issuing long-dated bonds will test the market’s appetite for risk at a time when a number of euro zone countries face political or economic uncertainty.
Italy is due to hold a referendum on constitutional reform sometime between Nov. 15 and Dec. 5, and Prime Minister Matteo Renzi has staked his future on winning it.
On top of that Spain is lurching towards its third election in a year following several failed attempts to form a government. Neighboring Portugal faces a possible downgrading of its credit rating by DBRS, the only remaining agency to give it investment grade status.
If this happens, Portuguese debt will no longer be eligible for the ECB’s quantitative easing programme.
Long-dated bonds are more sensitive to shifts in sentiment than shorter-dated debt, and, because of their relative illiquidity, appetite for them tends to fade during times of uncertainty.
So any attempt at a new issue could put pressure on prices, raising borrowing costs.
“I don’t think the countries have the necessary conditions to issue anything in the long end,” said Jaime Costero Denche, a bond strategist at BBVA. Only if investors were to start favoring longer-dated bonds for a number of months would it be possible for such issues to be successful, he added.
SPIKE IN DEBT
The temptation to issue long-dated bonds can be traced back to the crisis when a number of euro zone countries were forced to borrow heavily.
In Spain – which had to seek international help to rescue its banks – government debt jumped from the equivalent of 60.1 percent of its annual GDP in 2008 to 99.3 percent in 2013, according to Thomson Reuters data.
At the same time, investors’ aversion to risk forced Greece, Ireland and Portugal into full sovereign bailouts, while some other governments could borrow only over short periods, requiring debt to be frequently rolled over as it matured.
This has made countries anxious to extend the maturity of their debt to protect themselves from future shocks, said Ulrik Ross, global head of public sector and sustainable debt at HSBC.
They also want to set aside money for making interest payments at times of stress. “It does make a lot of sense to push out the average maturity and have cash buffers so that the liquidity and thereby coupon payments are not an issue,” he said.
Ross cited the example of Ireland, which issued long-dated bonds through the boom years of the early 2000s even though bankers at the time were pitching shorter deals at more favorable costs. This stood it in good stead when a banking crash forced it to take the bailout in 2010.
“Ultimately, when the crisis hit, the long average debt maturity profile did help at a very difficult time for the country,” he said. “So I would not blame other countries for taking this conservative option at all.”
(This version of the story has been refiled to correct spelling of name in 14th and 15th paras)
(Graphic by Nigel Stephenson; editing by David Stamp)
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