Spain selling debt like there's no tomorrow and they might be right !

http://www.reuters.com/article/2012/02/14/markets-bonds-spain-idUSL5E8DD3N320120214

REFILE-Spain risks choking market with bond supply glut

LONDON, Feb 14 (Reuters) - Spain's aggressive fund-raising in the bond market this year treads a fine line between a prudent dash for cash and squeezing investors too hard.

Madrid is running far ahead of the euro zone pack in terms of 2012 sovereign debt issuance, smashing its funding targets by cashing in on strong demand from domestic banks flush with money borrowed from the European Central Bank.

To date, Spain has raised 29 percent of the 86 billion euros it needs in 2012 compared with 18 percent of planned bonds sales by this time last year. In contrast, Italy has raised 10 percent and Germany 11.5 percent.

"They see an open window and are trying to secure as much liquidity as they can... Everyone was expecting some front-loading but this is unprecedented," said Michael Leister, strategist at DZ Bank in Frankfurt.

By issuing debt early and when demand is strong and yields low, Spain can save money and protect itself in case borrowing conditions worsen later this year.

But the strategy is not without risks. Demand for Spanish bonds has shown early signs of flagging as investors struggle to absorb the weight of supply, and primary dealers are beginning to feel the pinch after a run of above-target bond sales.

EARLY INDIGESTION WARNING

Spain got 2012 off to a flying start, selling double the amount it had targeted at the year's first auction, followed by a second above-target sale a week later. In early February it surprised markets by topping up a bond with a syndicated tap sale for the first time.

"Spain had the opportunity to speed up, they took it, and I think it makes sense," said one banker with direct knowledge of recent supply activity, who requested anonymity.

"Spain has seen a lot of volatility in the last year so it makes sense to do the funding while the demand is there."

Dealers say the majority of debt has been bought by Spanish banks, where demand has been buoyed by the availability of cheap three-year loans from the ECB which can be used to buy Spain's higher-yielding bonds for a profitable 'carry trade'.

But the same demand has driven yields sharply lower across the curve, squeezing some value out of the trade and there are signs that the early clamour for Spanish bonds is slowing.

"We saw last week when they did the surprising tap that dealers and the general market is filled to their teeth with Spanish paper," DZ Bank's Leister said.

Spanish debt underperformed after a Feb. 2 sale which hit the top of the target range, and the recent syndicated deal - a low-risk way of selling direct to investors - was cited as causing a sell-off in 10-year Spanish bonds the following day.

Nevertheless, the going remains good for now. Spain sells up to 4 billion euros of debt this week, including a tap of the January 2015 bond which now yields 2.9 percent - 200 basis points less than it cost to sell the same bond six months ago.

NOT EVERYONE'S A WINNER

Spain's target-busting approach to fund-raising this year comes at a cost to the primary dealer banks who are required to bid at the auction and sell the paper on to investors. That becomes increasingly difficult and expensive when the issuer sells a large amount of debt by accepting a wide range of bids.

"If you know someone else has bought the same bond half a point lower, you know they're not going to get back up to your level for some time and it just makes it all the more difficult to feel comfortable with the whole process," said a senior source at one primary dealer.

The primary dealer system was crucial in helping Spain weather intense market pressure at the end of 2011, when they bought bonds despite little demand from buy-and-hold investors.

Undermining that relationship could come back to haunt Spain if markets turn their back on higher-yielding assets again, or banks use the ECB cash to pay down their own debts.

"The glut of liquidity put in by the ECB is trumping fundamentals...which is why we believe that Spain and Italy are getting away these auctions at the levels they are. We believe it isn't sustainable and the effects of the LTROs (ECB long-term refinancing operations) will begin to wane," said Rabobank strategist Lyn Graham-Taylor.

The decision by rating agency Moody's to cut Spain's credit rating underscores the country's fundamental problems, which cannot be overcome by the provision of cheap cash to banks.

"The fiscal overrun from last year means they've got a very large task in terms of cutting back on spending, they've got difficulty in controlling the regions, and all this in a world where you're going to have a deeper recession," said Myles Bradshaw, a portfolio manager in charge of euro funds at PIMCO.

As a result of these concerns, many in the market believe Spain cannot sustain the pace of issuance seen early this year and, with yields at much lower levels than in January, expect a less explosive supply pattern over the rest of 2012.

"Naturally, you would expect that supply events calm down, start to become a bit more normal and price developments will be more balanced in this context," said Lee Cumbes, head of frequent borrower origination at Barclays Capital in London.