Investors venture into Spanish debt Before Spain was swept into the centre of Europe's sovereign debt crisis few investors paid much attention to the spending habits of the country's 17 autonomous regional governments. Now, with several of Spain's largest regions forced to turn to the country's central government for financial assistance as billions of euros of their debt repayments fall due later this year, local concerns have the ability to shake confidence in Madrid's ability to cope with its debts. Accounting for about a quarter of Spain's public debt, and a third of its public deficit, Spain's regions have been left unable to borrow from banks, and locked out of the capital markets that once freely lent them money during the country's construction bubble-led years of growth. In response, Mariano Rajoy, Spain's prime minister, has pledged that no region will be allowed to default, having established an €18bn central liquidity fund to help local governments to refinance. Catalonia, the country's largest region by output with an economy the size of Portugal's, this month became the most notable to tap the fund, requesting €5bn to deal with large looming redemptions. In spite of these reassurances, the yields on debt issued by the regional governments of Catalonia, Valencia and Madrid surged this year as investors have increasingly fretted over the Rajoy government's ability to keep its word. Yet in recent weeks, an increasing number of hedge funds and more intrepid institutional investors have begun to re-examine the potential rewards of buying up small issues of bonds issued by Spanish regions, which offer a significant return above Spain's own sovereign debt. "Provincial Spanish bonds have seen interest from ratings-insensitive investors drawn by high yields for quasi-sovereign risk," says Ewen Cameron Watt, chief investment strategist at BlackRock Investment Institute and chairman of the asset manager's central strategy group. This sudden interest, stoked by the expectation that the European Central Bank will soon begin buying up shorter-dated Spanish debt as Mr Rajoy moves closer to requesting a full bailout, has seen the yields on debt issued by Catalonia, Madrid and Valencia fall sharply since the start of the month. Having been priced at 6 per cent until May, the yield on bonds issued by Catalonia maturing in 2013 spiked to almost 15 per cent, before falling to 11 per cent after the offer of a bond buying programme by the ECB this month. A €1bn bond issue by Valencia maturing in 2015 offered a yield of almost 16.5 per cent until this month, when it fell back to 13 per cent. At the same time, continuing high yields indicate that the regional government leaders and Mr Rajoy have not entirely convinced foreign investors that it will be able to marshal enough liquidity to honour these debts in a worst-case scenario. Catalonia is the largest regional economy in Spain, but it is also the most indebted, with €26.2bn of bonds and loans due to be repaid over the next decade, according to Bloomberg data. The region has to make principal and coupon payments of €3.5bn this year, and €7.6bn next year. Valencia, another region that has had to ask for help, owes €6.9bn in public bonds and loans. About €1.5bn is due this year and next in repayments and coupons. Andalucia and Madrid both owe about €8.8bn. The former faces repayments and coupons of €697m this year and €2.3bn in 2013, while the latter is due to pay €261m in 2012 and €2bn next year. For adventurous investors confident that the most recent plan by European authorities to bring down Spanish borrowing costs will work, the high yields on these often small and illiquid issues represent one of the most attractive ways to bet on a rally in Spanish sovereign debt. But market participants say there is little sign yet that more than a handful of funds have snapped up this sub-sovereign debt, with many still concerned that Spain's central government may not be able to keep its verbal guarantee if the crisis escalates again. Until concerns over Spain's overall credit worthiness die down, any investment in regional government debt will remain attractive only for those with hearty appetites for risk. "There are a number of risks," says Nick Gartside, head of international fixed income at JPMorgan Asset Management. The ratings are lower, so some funds cannot hold them. They are much less liquid, and there is also a risk that the implicit government guarantee doesn't stand to the test. Given these risks, I can see why they should trade wider than Spain's government bonds.