Ireland under huge pressure

Forex Special :-
                            

Summary

• Ireland under huge pressure. 
• Introduction of senior debt burden sharing?
• Covered bonds taking a bigger chunk of wholesale funding.
• DONG Energy extends tender offer.

Market Comment

What a setback! In contrast to expectations, it took only a few minutes for investors to digest and ignore the announcement on Monday of the EU/IMF bail-out of Ireland before jittery markets took PIIGS spreads soaring again. In beautifully rounded numbers, currently Italy trades around 200 basis points, Spain 300bp, Portugal close to 500bp, Ireland close to a record-high of 600bp and Greece around 1,000bp. 

Now the big question is whether market participants will find the new Irish austerity measures credible, taking into consideration the fear surrounding the distressed banking sector. More dramatic measures in this respect are likely to be announced in the coming days. In context, S&P downgraded the sovereign rating of Ireland on Tuesday by two notches to ‘A’ with Negative Watch due to the troubled banking system and the need for further capital injections and supply of liquidity. `

According to www.Irishtimes.com, The EU/IMF delegation currently visiting Ireland is looking for a viable solution to include senior debt burden sharing in the rescue scheme for Ireland. The plan should be announced at the weekend, according to the newspaper. In order to avoid court objections to the proposal, the negotiators are seeking legal advice. Two different approaches are on the table: one for bank bonds to be converted to equity (bail-in) and one for bondholders to inject new capital or face haircuts. 

Whether this is feasible or not is difficult to predict, but the whole manoeuvre is having repercussions for both Irish debt and the broader financial bond markets, particularly the sub-debt markets. Anglo-Irish senior debt is down some four to seven full figures on the news and financial sub spreads have been hit hard.

Focus is now on the next peripheral in line – Portugal. Even if the current pressure on Portugal were to lead to unsustainable levels, we believe the EU would be able to cope with this. A stronger test for the eurozone would arise should Spain (due to the size of the economy) be the next PIIGS country to fall victim to heavy market turbulence, which we believe is likely. Consequently, we believe the ECB needs to reconsider its exit strategy from emergency measures, especially the withdrawal of bank liquidity support. The next ECB decision on the matter will be on December 2. Currently, the ECB provides unlimited liquidity for one week, one month and three months, at a fixed rate of 1%. 

As mentioned above, sovereign peripheral spreads continued to drift wider during the week with contagion to the broader CDS markets. The iTraxx Main and Crossover currently trade around 112bp and 497bp, which is 12bp and 42bp wider than Friday, respectively. As usual, when sovereign concerns resurface, iTraxx Senior Financials underperform and is 46bp wider at 172bp. An even more evident underperformance has been seen in the Sub Financials index which has increased 62bp since last Friday to 288bp. Today the multiple between the sub and  senior index is 1.70x – up from 1.44x just one month ago.

As always, developments in cash markets are steadier than indices but spreads are drifting wider and bid/offer spreads increasing.

The Primary Market

Primary issuance in corporate bonds has been rather subdued during the week due to market sentiment with a SEK1.5bn tap from Stora Enso and 8Y fixed maturities from ENI and Credit Mutuel the most interesting.

Increasing Covered Bond Issuance

While senior unsecured issuance has been modest recently, covered bond issuance has been more stable and the asset class is taking a relatively bigger chunk of the wholesale funding markets (see graph) below. Partly due to lower spreads for the issuer and partly spurred by new regulation. The liquidity coverage ratio and net stable funding ratio requirements in Basel III are benefitting covered bond securities in bank holdings of these instruments.

DONG Extending Tender Period

Following the announcement of DONG Energy's intention to tender its existing hybrid for either cash or a proposed new hybrid, DONG Energy this week announced that it was extending the tender period. Previously the tender offer was set to expire on November 23. On Tuesday DONG Energy announced that it had extended the tender period to today (November 26), at 17:00 CET. The extension is explained by technical issues causing DONG Energy to issue a prospectus supplement for the proposed new hybrid. 

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