Why CCT are priced below par

I take the opportunity of a question from a reader to speak a little about CCT, namely the Italian State bonds at variable rates.

Some day ago I spoke with a colleague of mine who deals with finance for many decades (I have not written badly, just for decades!) and has got a lot of historical experience to: one with white hair, then, that told me he never had seen the prices of CCT, since they exist, so depressed, at levels well below the par, i.e. their nominal value (100), even when, in the early 90s, the old Italian lira came out from the EMS.

Why CCT have lost so much value in recent months? The problems are basically two:


1) more credit risk for Italy

The perception of credit risk relating to European countries called "peripheral", such as Italy, Greece, Ireland, Spain, Portugal, etc. is certainly worsened, and partly was reflected in real downgrade, as the one which caused Spain to lose the triple A.

For Italy, in particular, this has led to a sharp rise in spreads on contracts of Credit Default Swap (CDS) relating to debt securities issued by the Italian Republic, currently at 165, the worst figure among the G7 countries, as demonstrated by the following table (source: Markit).


Certainly the comparison among G7 may leave some doubt, if only you consider that, for example, the CDS on Japan is quoted about one quarter of the italian one, although the japanese government debt levels are, in my opinion, much more worrying than that - so much blamed - of Italy (in terms of debt / GDP ratio, for example, it is almost 200% against 105% of the domestic case).

The Italy risk, however, is well represented also by the asset swap spread of BTP, a value which, in a nutshell, measure the difference between the interest rate of the BTP (the fixed rate italian government bond) and the swap rate for the corresponding maturity: currently is about 90 bps on the ten years maturity.

Similar measure, finally, is the spread between the Italian BTP and German Bund, equivalent to approx. 170 bps on the same maturity, level higher than the previous one, both for rating differences (Germany is Triple A, while the swap curve underlies a rating of AA), and because the German securities have strongly benefited from the so called flight-to-quality.

Whatever the measure used, however, it is clear that the Italian government debt is under pressure, in this historic moment, for a worsening (at least perceived) of the relative credit risk.


2) the indexing to the BOT and not to the Euribor

There is another factor against the CCT, as always, but particularly in recent months: the Italian floater bond is indexed to the interest rate of the Italian BOT (typically at 6 months, with the addition of a spread of 15 bps), rather than to the Euribor which, as you know, represent the financial benchmark reference on short maturities.

Since the financial crisis has forced up the Euribor rates, i.e. roughly since the second half of 2007 and until a few weeks ago, the Euribor-BOT spread has been abnormally positive and thus unfavorable to underwriters of BOT and, indirectly, to those of CCT.

The situation has gradually improved recently, primarily for the rapid fall in Euribor, but the spread remains at very high levels, equivalent to more than 60 bp, and then to about 45 bp on rates of CCT.


CCT still suffering

Both factors (italian credit risk and spread Euribor-BOT) thus play against the CCT and both effects could determine "curious" effects as the one that was afraid by the reader above mentionned: if, for example, the european benchmark rates increased, but, at the same time, the credit spread of Italy and/or the spread Euribor-BOT worsen, the CCT would be penalized again.

My impression is that the prices of CCT are not intended to improve soon: however, for other aspects, this fact represents a potential opportunity, as the securities purchased at a discounted price today will be redeemed at maturity at their nominal value (assuming that there will be no default of our country) and that, in any event, this is index-linked bond that do not suffer much of a (possible) upward move of the yield curve in Europe.


Original post: Perché i CCT sono sotto la pari