UPDATE 2-Spain begins marketing inaugural inflation-linked bond

Mon May 12, 2014 12:13pm EDT

(Adds quotes, rewrites throughout, adds new context)

By Sarka Halas

LONDON, May 12 (IFR) - Spain will this week become the second peripheral sovereign to sell eurozone inflation-linked debt, as it takes advantage of investors' appetite for its debt to diversify its buyer base.

With the exception of Italy, inflation-linked debt supply has come from core countries such as France and Germany. However, a heavily oversubscribed linker sold by Italy in March, its first since 2011, gave Spain the impetus to act on previously announced plans.

"With spreads continuing to grind tighter, this is something they have been considering for a long time and it comes on the back of the success of the Italian linker seen in March," said a banker working on the deal.

Lead managers Barclays, BNP Paribas, CaixaBank, Deutsche Bank, Santander and Societe Generale set initial price thoughts on the Baa2/BBB-/BBB+ rated issue at 100bp area through the 3.8% April 2024 Spanish government bond, which is slightly more than what Spain would have to pay to do a non-inflation linked issue.

"They will pay up a bit; it is their inaugural trade and investors will be compensated for it," said another banker working on the deal. He added that the Italian BTPei cheapened up a bit by 2bp-3bp on Monday, in order to make way for Spain's new linker.

Leads looked to Italy's inflation-linked bond for thoughts on pricing, with one lead placing fair value on Spain's debut at 113bp-115bp.

"Breakeven IPTs at 1% offer good diversification for investors. Before this bond, it was only Italy that offered non-core inflation debt," said a banker working on the deal.

Italy sold a 4.5bn September 2024 bond at 16bp over its 2.6% September 2023 BTPei, attracting 10bn of demand.

Spain was last in the syndicated market with a 10-year bond back in January, when it sold a massive 10bn of conventional debt at 178bp over mid-swaps and offering a coupon of 3.8%.

"This is for investors looking to diversify their holdings, the new bond gives them another way of getting their hands on Spanish risk," said another banker working on the deal, which matures November 30 2024 and which will be linked to the European Harmonised Index of Consumer Prices excluding tobacco.

Inflation-linked bonds are designed to help protect investors from inflation and are primarily issued by sovereign governments, with the principal and interest payments rising and falling with the rate of inflation.

However, the eurozone rate declined for most of 2013 and the European Central Bank said on Monday that inflation in Europe will probably stay below 1% for an extended period, before being slated to pick up again to 1.3% in 2015.

"Is it an inflation play or a credit play for investors?" one syndicate banker working on the deal asked.

FALLING YIELDS

The rally in peripheral yields since the start of the year is evidence of how much more comfortable accounts are with risk in countries like Spain, and this new bond gives them another way to snap up Spanish debt.

The new note will give investors exposure to a greater eurozone economy that is at last showing signs of picking up steam after years of being stuck in a rut.

The yield on Spain's 10-year bond has dipped below the key 3% threshold and is now trading at 2.93%, according to Tradeweb.

Recent scheduled auctions have seen yields drop to record lows, and the premium investors demand to hold Spanish over German debt has dropped to its lowest levels since August 2010, at around 145bp, a long way from the more than 650bp at the height of the eurozone debt crisis.

Following its last bond auction, Spain had sold 46.7% of its medium and long-term debt target for 2014.

Last December, Pablo de Ramon-Laca, head of funding and debt management at the Treasury, said issuance would not be opportunistic but rather a liquid programme with a view to forming a curve. (Reporting by Sarka Halas, editing by Helene Durand, Julian Baker, Sudip Roy)

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