COMPARATIVE ANALYSIS OF BOND MARKETS IN SPAIN, PORTUGAL,

SLOVAKIA, SLOVENIA & ROMANIA

Submitted By:

Shriya Nayyar, Sonam Jambhulkar, Pranjal Mehta, Aditya Pratap Singh & Taniya Kanwat

What is a Bond?

A bond is a loan that the bond purchaser, or bondholder, makes to the bond issuer. Governments, corporations and municipalities issue bonds when they need capital.

An investor who buys a government bond is lending the government money. If an investor buys a corporate bond, the investor is lending the corporation money.

Like a loan, a bond pays interest periodically and repays the principal at a stated time, known as ‘maturity’. 

The yield of a debt instrument is the overall rate of return available on the investment.

Because of the inverse relationship between bond valuation and interest rates, the bond market is often used to indicate changes in interest rates or the shape of the yield curve.

Basics of Debt Markets: The debt market is a market for buying and selling of

debt securities. It is divided into the Primary Market (for issues of bonds)

and Secondary Market (for buying and selling of bonds). Secondary Markets can operate via exchanges or OTC

operations. Bond market participants are similar to participants in

most financial markets and are essentially either buyers (debt issuer) of funds or sellers (institution) of funds and often both. Participants include- Institutional investors, Governments, Traders and Individuals.

Bonds can be of various kinds, namely- Government Bonds, Corporate Bonds, Municipal Bonds, Collateralised Debt Obligations (CDOs), etc.

Bond Markets Volatility: When interest rates increase, the value of existing bonds falls, since new issues pay a higher yield. Likewise, when interest rates decrease, the value of existing bonds rises, since new issues pay a lower yield. This is the fundamental concept of bond market volatility—changes in bond prices are inverse to changes in interest rates.

Fluctuating interest rates are part of a country's monetary policy and bond market volatility is a response to expected monetary policy and economic changes.

Credit Risk and Credit Rating of Bonds: Every bond also carries some risk that the issuer will “default,” or fail to fully repay the loan. Independent credit rating services assess the default risk, or credit risk, of bond issuers and publish credit ratings that not only help investors evaluate risk but also help determine the interest rates on individual bonds.

An issuer with a high credit rating will pay a lower interest rate than one with a low credit rating. Again, investors who purchase bonds with low credit ratings can potentially earn higher returns, but they must bear the additional risk of default by the bond issuer. 

Debt Market in Spain

Spanish Debt Market

Reducing Debt and Increasing Competitiveness: As specified in the government’s medium-term fiscal plan, return to a cyclically-adjusted fiscal balance by 2017.

Sustainably boosting medium-term growth and jobs: Strengthen active labor market policies by improving vocational training, strengthening the capacities and efficiency of the public employment services and enhancing coordination between the different levels of administration.

Towards a higher performing business sector: Broaden the corporate tax base, lower the rate and eliminate special regimes for small medium-sized enterprises.

Overview of the Spain Debt Market

The Spanish economy returned to positive growth in the second half of 2013 on the back of a reduction of financial tensions, notably thanks to announcement of outright monetary transactions by the President of the European Central bank(ECB), and the increase in confidence that followed adoption of key reforms and measures in Spain from 2012 onwards.

Medium-term fiscal sustainability is improving:Sovereign spreads have fallen significantly since July 2012 to levels not seen since since May 2010, allowing Spain to service its debt at declining costs.

With the onset of the crisis, credit to firms began to contract affecting all economic sectors and both large and small firms.

Seventeen EU member states registered deficits higher than the maximum ceiling of 3 percent of GDP. The budget deficit of Greece increased to 10 percent from 9.5 percent in 2011.As a percentage of GDP, the Spanish government debt surged to 84.2 percent in 2012 from 69.3 percent in 2011.The increase in deficit is another blow to the government that stands firm on spending cuts even in the midst of recession and record unemployment. The government is expected to unveil new budget plans on Friday, emphasizing on growth.

Prime Minister Mariano Rajoy has requested the EU to relax its deficit target for 2013 to 6 percent of gross domestic product compared to the previous goal of 4.5 percent Helped by widespread austerity measures, the combined budget deficit of the euro area fell to 3.7 percent of GDP from 4.2 percent in 2011. Meanwhile, government debt increased to 90.6 percent of GDP, above the 60 percent ceiling, from 87.3 percent in the previous year.

Recently the European Commission estimated the Eurozone deficit to narrow to 3.5 percent of GDP in 2012 and then to fall to 2.8 percent in 2013.The EU27 budget gap also declined in 2012, to 4 percent of GDP from 4.4 percent a year ago. The lowest government deficit in percentage of GDP was registered by Estonia, followed by Sweden, Bulgaria and Luxembourg. Only Germany posted a budget surplus at 0.2 percent.

Towards a more dynamic business sector in Spain

Policy efforts to revitalize entrepreneurship and investment in Spain are key to generating growth and new jobs.

The government has a substantial reform program to make it easier to do business in spain, which should in some cases be deepend.

Boosting economic growth requires a new generation of high-growth companies and that resources flow towards

the most productive firms.

Strategies towards more diversified financing

Bank lending has traditionally been the predominant financing sours in Spain.

With the crisis, larger companies have raised capital directly from the markets, although less than in other European countries.

Recent government initiatives(notably the strategy to promote non-bank financial intermediation under the Memorandum of Understanding agreed with European authorities) attempt to fill gaps, with a special focus on start ups.

New Developments in Spanish Market Regulation

Recent happenings: Spain hit two milestones in debt-market rehabilitation on May

12, 2014, with a debut inflation-linked government bond and the first post bailout junior bonds from lender Bankia SA.

The government raised $6.9 billion with a 10year bond, whose returns reflect European harmonized consumer price index.

The issuance allows Spain to join a small group of euro-zone members-Germany, France and Italy that sell inflation linked bonds on a regular basis.

Small euro zone countries with lower funding needs are unlikely to flow suit as the issuance of so-called linkers doesn’t normally exceeds 10% of a country’s annual government bond issuance.

Debt Markets in Romania

General InformationTwo types of bonds – municipal and

corporate bonds.The currency of Romania is lou (‘lew’).It acceded to the EU in 2007 but is yet to

adopt euros as its currency.The structure of the market – 8.52 % is

owed to the bond sector, the equity transactions accounting for 91.47 % of the total amount.

Municipal Bond MarketThe agency that handles it on behalf of

the government is the Ministry of Public Finance (MPF) and National Bank of Romania (NBR).

Issuance of government bonds can be traced back to 1994.

• This reflected a greater capacity to pay back. However, the Bucharest Stock Exchange has a lesser trading volume. This has been ascribed to the late introduction of treasury bonds in the market (seven years after the bond sector was launched).

For the domestic market, the Romanian MoPF also issued securities denominated in USD, DEM, and EUR. The issuance of USD denominated Treasury bonds started in 1998. Since 2006 no USD denominated issues were offered on the domestic market. Starting with 2006, EUR became the main currency against which Romanian leu exchange rate is reported due to the approaching expected accession to EU.

Corporate BondsHigher rate of interest for corporate

bonds, as the risk is higher.The first corporate bonds issued in 2003 –

nascent market and not very well developed.

Debt Market in Slovenia

Overview of the Slovenian Debt Market

Slovenia became independent in 1991. It joined the Euro Zone in 2004 & adopted the Euro in 2007. With the

adoption of the euro in 2007, the infrastructure of domestic government debt market was further integrated to the EU market.

Ever since, bonds are "ECB eligible" and banks can use them as collateral for borrowing at the Euro system.

Notwithstanding Slovenia’s efforts to bring its securities market legal infrastructure in line with EU directives, capital markets in Slovenia are not well developed by OECD standards.

Upon adoption of Euro in 2007, Slovenia faced a credit boom in the construction sector, which made it plunge into double dip recession post 2008, with huge sovereign debt and non-performing loans (NPLs).

In 2012, this banking crisis seemed headed towards a bailout situation, but was redeemed by a restructuring of the banking sector.

Since 2014, the credit ratings of Slovenia have again become stable from negative.

Slovenian Bond Market & Types of Bonds

Slovenian companies mostly prefer bank loans as a source of funds, because it is relatively cheap, so the bond market is largely undeveloped. While a handful of companies draw upon fixed-income instruments, many of the largest companies are funded directly by loans from foreign banks, via domestic subsidiaries, foreign branches, or directly from abroad.

Slovenia’s capital markets are extremely limited in both depth and liquidity, and have a narrow, largely domestically focussed investor base.

The following bonds are mainly issued:

1. Government Bonds

2. Corporate Bonds

3. Mortgage Bonds

4. Municipal Bonds Bank-issued bonds & government bonds are most popular. Corporate bond market is relatively underdeveloped.

Types of Issuers

Before the introduction of the euro, about 80 percent of the issues were placed with local investors.

The group of primary dealers has been internationalised since 2007. Two groups of primary dealers, one group of primary dealers for government bonds and another group for treasury bills exist.

The group of primary dealers for government bonds currently consists of 9 institutions, 3 local and 6 international.

Security brokers and mutual funds are important class of investors.

Slovenia is considering adding more international institutions to its primary dealers group.

Government Bonds

Government securities market is traditionally one of the most efficient segments of financial market. It is used by a variety of market participants including for conducting monetary policy.

Government bonds are of 2 kinds:

a) Long term bonds- Includes public offering of benchmark bonds, issued on European or other financial markets via syndication, bond issue via auction, a private placement of bonds, bank loans, etc.

b) Short Term debt- 3, 6, 9 and 12-month T-bills In accordance with the agreement between the Ministry of Finance and

the Ljubljana Stock Exchange (LJSE), all government bonds are listed on Ljubljana Stock exchange.

Only Eurobonds and bonds issued for special restructuring and restitution purposes are exempt from this agreement.

The Bond auctions are executed in two phases:

a) 1st phase – by competitive bidding and

b) 2nd phase - by non-competitive bidding.

Other Bonds

Corporate bonds less preferred due to higher transactional costs. Slovenian companies mostly prefer bank loans as a source of funds, because it

is relatively cheap. many of the largest companies are funded directly by loans from foreign banks, via domestic subsidiaries, foreign branches, or directly from abroad.

Corporate bonds represent roughly 5% of the total market capitalisation of bonds and amounts to less than 1% of turnover in bonds.

In 2014, the Ljubljana Stock Exchange listed 49 bank-issued bonds, 14 corporate bonds, 1 insurance company bond and 25 government/public bonds.

Mortgage bonds and municipal bonds are bonds issued under the terms and conditions of the Mortgage Bonds and Municipal Bonds Act and backed by cover assets; the holders of such bonds enjoy a senior position on repayment from such assets.

Credit Rating Agencies- In Slovenia credit rating agencies are not subject to special regulations. Yet, the Agency of the Republic of Slovenia for Public Legal Records and Related Services (AJPES) is an indispensable primary source of official public and other information on business entities in Slovenia and works like a credit rating agency.

Impact of the 2008 Financial Crisis

Slovenia experienced a dramatic boom and a continuing bust. In the run-up to its joining the euro in 2007, the country’s economy sharply expanded, only to burst under the weight of the financial crisis. The pre-crisis boom, driven by easy access to external funding and excessive risk taking by banks and businesses, has led to a protracted bust, which is compounded by domestic structural weaknesses and the European debt crisis.

As a result, Slovenia entered a double-dip recession. With high credits in construction sector, Slovenia faced a housing bubble. Most affected were the banks, the largest of which are owned by the

Slovenian government. About 20% of loans on average are non-performing.

Concerns about the quality of bank assets made it harder for the Slovenian government to fund its borrowing.

Yields on Slovenian government bonds—which reflect the government’s likelihood to repay its debts- rose.

State-owned banks had around 7 billion euros of bad loans, equal to about 20% of GDP.

Recovery from the 2008 Recession Fears of the “7% Curse”: In 2012-13, there were international fears

that Slovenia would follow Cyprus as the next Euro Zone nation seeking a bailout. This was because like in Greece, Portugal and Ireland, it was believed that yields would reach 7% and then, international bailout would be sought.

However, since 2014, recovery has been made. This was fuelled by:

1. Establishment of “Bad Bank”- Given the absence of a specific bank bankruptcy law in Slovenia, the Bank Asset Management Company (BAMC), created in October 2012, brought a restructuring of the banking system. It took over NPAs in return for government-guaranteed bonds of up to 11% of GDP. In this way, the remaining banks could focus on normal banking operations, while the BAMC would specialise in the recovery of bad assets. Also done in Spain & Ireland.

2. Exports- Slovenia’s main stronghold is exports and despite the recession, exports have remained strong and helped in economic recovery.

3. Recapitalisation of state owned banks

Credit Rating of Slovenian Bond Markets

As of 2014, yields and credit-default swaps on Slovenian bonds have fallen significantly, as it became apparent that the country was likely to avoid an international bailout, and as plans for fiscal consolidation and banking consolidation were set out.

In 2011, Moody’s downgraded the country’s long-term credit rating to “junk” or sub-investment grade.

On 23 January 2015, Moody’s restored its rating as investment rate. It upgraded Slovenia’s rating to Baa3 from Ba1.

Similarly, S&P changed Slovenia’s credit rating outlook from negative to stable. It cited the stabilization of the banking industry, fiscal consolidation efforts and the likelihood that it will continue the overhaul of the economy, for this upgrade.

However, while Banking Sector Restructured, corporate bonds still overleveraged.

Debt Market in Slovakia

Slovak Debt Market

Instruments of Debt Market: government securities (government bonds and T-bills), corporate bonds, bank bonds and municipal bonds.

History of Debt Market: Bonds were first issued in 1990 and issuance has increased steadily ever

since. Trading volumes in the secondary market, where all deals are traded on the Bratislava Stock Exchange, have also increased.

Until 31 December 2005, the supervision of the financial market in the Slovak Republic was undertaken by two supervisory bodies - the Financial Market Authority (FMA) and the National Bank of Slovakia - while the Ministry of Finance retained regulatory powers.

In 2006 the FMA was dissolved and its powers transferred to the National Bank of Slovakia, which cooperates with the Ministry of Finance for the enactment of capital market regulations.

In 2014 Slovakia has adopted a new legislation to  regulate its debt market.

Overview of the Slovak Debt Market

The Slovak capital market has been one of the least active. Bank deposits are the preferred way of saving, and bank loan financing has long been almost the exclusive source of funds for local corporaThe Slovak capital market has been one of the least active. Bank deposits are the preferred way of saving, and bank loan financing has long been almost the exclusive source of funds for local corporates.

The government and banks with their mortgage-covered bonds have been the only active issuers in the Slovak market.

The result is that market capitalization was less than 5% of Slovak GDP in 2012, compared to almost 20% in the Czech Republic and almost 40% in Poland.

The size of the Slovak economy is small, it is unlikely its capital market will ever become substantive even in regional terms. But it can provide a viable alternative to bank financing and tangible benefits for real economic growth.

Strategy for Development of Capital Markets The government adopts a mid-term strategy for the

development of the Slovak capital market. The strategy sets out a number of specific actions to be taken

by the government at the legislative and public policy level aimed at unlocking the potential of the Slovak capital market.

The measures include the introduction of new types of investment instruments, as well as modernization of the existing legal framework for bonds, investment certificates, and derivatives.

Important changes are contemplated in the regulation of collective investments, pension funds, and market infrastructure, mainly by reforming the Slovak securities registration system

Offerings of Debt Capital Market

Capital markets tend to evolve from offerings of bonds by government agencies or major corporates. A feasibility study of retail government bond offerings is currently being prepared.

Traditionally, Slovak government bonds are placed through bank syndicates or directly via auctions. The direct economic incentives of retail offerings, which tend to be more costly than wholesale transactions, are questionable. But there are emerging clusters of issuers around major Slovak investment groups.

Some of them are financial conglomerates, including banks, investment firms, and asset managers, and all are able to place instruments issued by related corporates within their groups and into their relatively broad client bases.

Effect of Recession on Slovak Economy

The Slovak economy experienced a strong but short recession in 2009. The recovery afterwards was driven by exports and investment.

While GDP growth was one of the strongest in OECD, employment did not reach the pre-crisis level and unemployment remains stubbornly high and rate of non performing  loans went high.

To deal with the recession the Slovakian government adopted the method of internal devaluation with productivity increasing measures, including capital deepening and laying off low productivity workers.

the Slovak economy recovered as early as 2010 and returned almost to the “normal” pre-boom growth rates of about 4 per cent in 2010 and 2011.

New Bond Legislation for Slovak Market regulation

Developments in Law: September 1, 2014, a major amendment to Slovak bond

legislation entered into force. The legislation introduces the concept of secured and

subordinated bonds, which existed before on "contractual" basis with no legislative support.

Effect of Tax: Withholding tax on income from Slovak bonds was abolished for most investors. Currently only Slovak natural persons and non-profit organizations pay withholding tax. Foreign investors are generally not subject to Slovak taxation on bond income at all. This change was an enabling factor for major Slovak issuers to enter the

Eurobond market.

In the context of the secured bonds, Slovak law for the first time now recognizes the concept of security agent. An issuer's obligations can be secured by entering into a pledge agreement with the security agent who has the right to enforce for the benefit of all bondholders.

Slovakia is a civil law jurisdiction, of course, so these concepts should not be confused with common law trust. More likely, the new concepts will be interpreted by jurisprudence and case law along the lines of traditional concepts of agency and commission.

The new legislation also provides for statutory infrastructure for bondholder meetings, the possibility of changing the terms and conditions, and generally reducing the amount of administration associated with a bond transaction.

Recent Ventures

Slovakia entered into foreign debt market with 12 year bond to keep its debt load below legal limits that would force budget cuts.

Slovakia last tapped euro markets a year ago, when it sold a 15-year, 1.5 billion-euro bond at 105 bps over mid-swaps, expectation is that European Central Bank will loosen policy.

Slovakia's debt is below 55 percent of GDP, well below euro zone averages. Its economy is expected to grow 2.6 percent in 2015, up from 2.4 percent forecast for this year.

The country has benefited from recovering growth, falling deficits and demand for yield in Europe's low-interest-rate environment.

Debt Market in Portugal

Portuguese Financial Crisis The Great Recession in Portugal led to the county

being unable to repay or refinance its government debt without the assistance of third parties. To prevent an insolvency situation in the debt crisis Portugal applied for bail-out programs and has drawn a cumulated €79.0 billion (as of November 2014) from the International Monetary Fund (IMF), the European Financial Stabilisation Mechanism (EFSM), and the European Financial Stability Facility (EFSF).

Greece and Ireland also went into a debt crisis in 2010. Together these debt crisis of these three countries marked the start of the European sovereign debt crisis.

Anxiety on financial markets

After the financial crisis of 2007-08, it was known in 2008-09 that two Porutguese banks (Banco Portuguese de Negocios (BPN) and Banco Privadi Portusues BPP) had been accumulating losses for years due to bad investments, embezzlements and accounting The case of BPN was particularly serious because of its size, market share, and the political implications - Portugal's then current President, Cavaco Silva, and some of his political allies, maintained personal and business relationships with the bank and its CEO, who was eventually charged and arrested for fraud and other crimes.

In the grounds of avoiding a potentially serious financial crisis in the Portuguese economy, the Portuguese government decided to give them a bailout, eventually at a future loss to taxpayers.

In the opening weeks of 2010, renewed anxiety about the excessive levels of debt in some EU countries and, more generally, about the health of the Euro spread from Ireland and Greece to Portugal, Spain, and Italy. In 2010, PIIGS and PIGS acronyms were widely used by international bond analysts, academics, and the international economic press when referring to these underperforming economies. The PIIGS or PIGS acronym is largely responsible for the loss of trust of investors in the country.

Austerity measures amid increased pressure on government bondsInternational Financial Market compelled the

Portuguese Government to make radical changes in economic policy, like other European governments had done before. Thus, in September 2010, the Portuguese Government announced a fresh austerity package following other Eurozone partners, through a series of tax hikes and salary cuts for public servants In 2009, the deficit had been 9.4 percent, one of the highest in the Eurozone and way above the European Union’s Stability and Growth Pact three percent limit.

In November 2010, risk premiums on Portuguese Bonds hit euro lifetime highs as investors and creditors worried that the country would fail to reign in its budget deficit and debt. The yield on the country's 10-year government bonds reached 7 percent – a level the Portuguese Finance Minister ad previously said would require the country to seek financial help from international institutions. Also in 2010, the country reached a record high unemployment rate of nearly 11%, a figure not seen for over two decades, while the number of public servants remained very high.

Re-access to financial markets

A positive turning point in Portugal's strive to regain access to financial markets, was achieved on 3 October 2012, when the state managed to convert €3.76 billion of bonds with maturity in September 2013 (carrying a 3.10% yield) to new bonds with maturity in October 2015 (carrying a 5.12% yield). Before the bond exchange, the state had a total of €9.6 billion outstanding notes due in 2013, which according to the bailout plan should be renewed by the sale of new bonds on the market.

As Portugal was already able to renew one-third of the outstanding bonds at a reasonable yield level, the market now expect the upcoming renewals in 2013 also to be conducted at reasonable yield levels. The bailout funding programme will run until June 2014, but at the same time require Portugal to regain a complete bond market access on September 2013. The recent sale of bonds with a 3-year maturity, was the first bond sale of the Portuguese state since requesting the bailout in April 2011, and the first step slowly to open up its governmental bond market again. Recently ECB announced they will be ready also to begin an additional support to Portugal with some yield-lowering bond purchases

When the country regain complete market access.

All together this bodes well for a further decline of the governmental interest rates in Portugal, which on 30 January 2012 had a peak for the 10-year rate at 17.3% (after the rating agencies had cut the governments credit rating to "non-investment grade" -also referred to as "junk”) and as of 24 November 2012 has been more than halved to only 7.9%