How Yields are Set in Bond Auctions

We’ve had lots of comments about yesterday’s bond auction, many of them from people confused by headlines about the “heavy demand” for the bonds. If the demand was so heavy, these folks are asking, why couldn’t we have sold the bonds at a lower interest rate? We’ve also had some good responses from people who know the answer but it’s perhaps worth putting the answer on the front page.

Take the €1 billion euro 8-year bond that was issued yesterday. The interest rates that we pay on these bonds are determined in an auction. People submit private bids detailing how much of the debt they want to acquire and what rate they are willing to pay. NTMA want to pay the lowest interest rates possible, so they allocate the bonds to those offering to take the lowest interest rates until they have handed out the full €1 billion of bonds.

Yesterday’s auctions featured €2.9 billion in bids (this is what is meant by the bid-cover ratio being 2.9) and the widely-advertised rate of 6.046% was the highest rate offered that received a full allocation of debt. The business about the “heavy demand” relates to the fact there were €1.9 billion in bids from people who were not allocated bonds. Pretty clearly, however, the existence of these bids can’t lower the rates that we are actually paying since these people weren’t willing to purchase the bonds at lower interest rates.

Also, we don’t know how serious all of these unsuccessful participants were. For all we know, some could have submitted bids at 10%: NTMA don’t release information about the nature of the unsuccessful bids. In the absence of this information, I’d recommend not reading too much into bid-cover ratios.

(Note, for those who want to be picky, I’m deliberately not getting into technicalities about Dutch and non-Dutch auctions and the like but informed commenters can fire away on this stuff if they wish.)

Central Bank and NTMA Annual Reports

The Central Bank have released their annual report (press statements from Governor Honohan here and from Chairman of the Regulator Jim Farrell here).  The NTMA has also released its annual report here and its mid-year business review here.

NTMA Bond Issue: Yields Up Sharply

Amid all the coverage of the banking reports and the other ongoing political stories, very little coverage has been devoted to the fact that the bond markets are again turning less and less positive about Irish sovereign debt.

Today’s NTMA bond auction (press release here) saw it borrowing €1.5 billion, equally split between a bond maturing in 2016 and a bond maturing in 2018. The NTMA press release stresses the fact that the auctions had bids of three times the amount offered. However, look at the yields. As the RTE website points out “The average yield on the 2016 bond rose to 4.521% from 3.663% at the last comparable auction in April and the 2018 bond had a yield of 5.088% from 4.55% last August.”

On the secondary market, the yield on ten year bonds has now given up most of the large decline that occurred after the May 9 announcement of the EU stabilisation fund. In fact, the FT are reporting that, as of yesterday, the spread over bunds stood at 281 basis points, relative to 319 basis points on Friday May 7, and yields are up another 20 or so basis points so far today.

What’s odd, of course, as Paul Krugman has been pointing out is that these developments have not stopped the constant references, both here and abroad, to how well regarded Ireland is by participants in international financial markets. 

To be fair, I think there are a few cross-currents here that go beyond the essential point that Krugman is trying to make. I would echo Krugman’s concerns about the effects of imposing fiscal austerity too soon. The budget deficit for the Eurozone as a whole is projected to be 6.6 percent of GDP this year, so to my mind the need for generalised fiscal contraction today is overstated in light of the weakness of the Euro area economy. However, the bond market’s attitude to Ireland’s position is such that the Irish government has little choice but to adopt an austerity program, a point that Krugman has conceded before.

Furthermore, I’m sure that financial market participants are impressed by the fiscal retrenchment obtained so far. But, at the end of the day, the bond yields give us their judgment on the sustainability of our situation and it’s a thumbs down. The high yields being imposed on us reflect the scale of the initial hole we dug for ourselves as well as policies that maximized the cost to the state of the banking crisis.

New Responsibilities for NTMA

A busy day, with lots going on. But I think it’s worth flagging this story about new responsibilities for the NTMA.

The move is understood to be aimed at creating a sharper focus on the State’s financial interest in the banks, while leaving Mr Lenihan and the Government to address broader economic and social concerns.

It may also serve to alleviate European Commission concerns about political interference in day-to-day financial decisions being made by institutions receiving support from the State.

The main functions being delegated include discussions with the so-called covered institutions about their capital needs, as well as discussions in relation to “realignment or restructuring” within the banking sector.

The NTMA will also be delegated with the Minister’s powers in relation to the management of the State’s shareholdings in credit institutions, and some remaining functions under the State guarantee scheme.

It will also be delegated functions in relation to the giving of advice on banking matters generally, including issues relating to crisis prevention, management and resolution.

The distancing of the managing of the state’s control in banks that may soon be partly or fully nationalised is a good idea. The rest of the announcement I’m more puzzled by. I would have thought that the capital needs of the banks was an issue for the Central Bank to discuss with the covered institutions rather than the NTMA.

More generally, I can’t imagine there are too many countries that use their government bond issuance office for “advice on banking matters generally, including issues relating to crisis prevention, management and resolution” so I’m not sure why we are.

Constantin Gurdgiev discusses the annoucement here. He argues that there is a conflict of interest between obtaining the best return for NAMA and obtaining the best return on the government’s bank shares, presumably in relation to the pricing of the assets to be transferred.  Of course, if the government owns both the banks and NAMA, this conflict of interest would more of an ecumenical intra-NTMA matter.

NTMA Review of 2009

The NTMA has released its review of its 2009 activities. Link here.

In relation to the coming year, the report says that “The NTMA plans to raise up to €20 billion in the bond markets in 2010. This requirement is significantly less than in 2009 because of a smaller projected Exchequer deficit of €18.7 billion and a lower refinancing requirement of €1.2 billion.”

These figures do not include any allowance for any borrowing that may be triggered by bank recapitalisation requirements. That said, the National Pension Reserve Fund had a good year thanks to the rise in international stock markets and its value now stands at €22.3 billion. Excluding the €7 billion held in preference shares in AIB and BOI, this leaves €15 billion that could, potentially, be used to recapitalise the banks without borrowing.