Euro periphery premium over company debt highlights credit risk

LONDON Tue Dec 10, 2013 11:01am EST

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LONDON Dec 10 (Reuters) - Fear of the euro zone breaking up has all but vanished but the extra return Spanish and Italian government bonds offer over corporate paper suggests investors remain nervous that some states may not repay all their debts.

Corporate bonds normally yield more than sovereign debt since companies are seen as more likely than states to go bust. However, after EU governments like Portugal and Greece had to be bailed out, that relationship reversed for countries on the euro zone periphery, including major economies Italy and Spain.

A Reuters analysis [link.reuters.com/wyr35v] shows that the premium investors demanded to hold Italian government bonds over similarly BBB-rated corporate debt from across the euro zone rose to nearly 300 basis points in the middle of last year, while Spain was paying a premium of nearly 400 basis points.

A steady narrowing since the European Central Bank stepped in to reassure markets it would not allow the single currency to disintegrate has brought both those yield differentials back to about 70 basis points - a level showing investors still have greater confidence they will be repaid by the euro zone's big companies than either of the governments in question.

"There is still a default risk which is more difficult to get rid of because we don't have a full-blown fiscal union," Elwin de Groot, senior market economist at Rabobank, said.

While the risk of, say, Spain quitting the euro zone and repaying borrowers in devalued pesetas has largely gone, there is still a risk it might not repay its euro debts in full since neither other states, nor the ECB, are obliged to help it out.

Germany and France pay less than corporates to borrow.

Data also shows Italian and Spanish sovereign yields are higher, on average, than on corporate debt from the countries themselves, stripping out the debt of companies from other euro zone states, such as highly rated Germany and France.

The Madrid government is paying nearly a quarter more for its medium-term borrowings than, for example, Spanish telecoms firm Telefonica, while Italian energy utility Enel can raise debt more cheaply than Italy itself.

Calculations by Fathom Consulting using Thomson Reuters data show the average yield, weighted by volumes outstanding, for 10-year Italian corporate debt within the euro zone basket was 2.4 percent, compared to 4.09 percent on 10-year Italian government bonds. For Spain, the average BBB corporate yield is 2.0 percent, below Madrid's 10-year yield of 4.06 percent.

A range of factors may be at work. Unlike governments, big corporations have broad, global income streams, for example.

But the fact that sovereign yield premiums over corporate bonds have failed to disappear on the euro zone periphery after emerging in 2010 with the bloc's debt crisis, implies continued investor unease with government finances.

Rabobank's de Groot said levels of debt in Italy and of the budget deficit in Spain were causes for concern, particularly as growth is still anaemic to negative in both countries. (Graphic by Vincent Flasseur; Editing by Nigel Stephenson and Alastair Macdonald)

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