The emergence of the European Financial Stability Facility and the European Stabilisation Mechanism has changed market dynamics as the EFSF has been transformed from being an insurance policy to a major European debt issuer.
As the role of the EFSF and the ESM has continued to grow, investors are now expecting higher returns from the EFSF as it becomes a more permanent feature of the SSA landscape. The EFSF was created in June 2010 to help resolve the potential sovereign funding crisis within Europe. Despite having a three-year operational life, the EFSF will exist as long as it has outstanding debt alongside its planned successor, the ESM.
The EFSF sold its inaugural debut issue in January 2011. The transaction received one of the strongest receptions in memory from across the investor spectrum dispelling any doubts surrounding its ability to access funding. As it became apparent that more sovereigns were going to need assistance, the EFSF’s structure was found to be wanting and adjustments were made. The framework for the EFSF’s successor was laid out as it became obvious that Greece would have to roll over its first rescue package.
The burgeoning needs of Europe’s sovereigns have, however, already made the group one of the largest bond issuers in Europe and while the spreads of German issuers have tightened, the EFSF’s spreads have widened in the secondary market.
Origins of the EFSF
The inability of Greece to service its outstanding debt and to raise finance in its own right in April 2010 led the sovereign to seek assistance from both Europe – in the form of bilateral loans – and the IMF. Between them a bail-out package totalling €110bn was put together but at the time it wasn’t clear if Greece was an isolated case or, as is now known, just the first in the queue. This led European leaders to consider the unthinkable, the creation of a bail-out mechanism for sovereigns that had lost direct market access.
The creation of the EFSF was the main outcome of those considerations, a fund backed by the guarantee of 17 member states which could provide up to €440bn of financing to any sovereign in need of assistance. Along with €60bn from the European Financial Stabilisation Mechanism, based on the budget of the European Union and a further €250m from the IMF, it was thought that €750bn would be enough to cover Europe’s needs and restore the faith of investors in the eurozone.
To minimise costs and to ensure funding was at the cheapest level possible it was imperative for the EFSF to achieve a highly sought after Triple A credit rating and thereby position the issuer alongside comparable entities such as the EIB and the EU. The demands of the rating agencies to grant this rating, however, resulted in a much lower borrowing capacity and a rather cumbersome over-guarantee structure in which a certain amount of the €440bn was invested in Triple A securities to provide a buffer to neutralise the credit ratings of the weaker member countries.
As a result, the effective lending capacity was cut to about €255bn and the questions of whether the EFSF’s “firepower” was enough to ensure its ability to support sovereigns in need were again rekindled. To address this issue an increased EFSF was proposed with the maximum guarantee commitments raised to €780bn, enabling a full €440bn to be on lent based on the higher proportion guaranteed by the stronger eurozone members.
Market reaction
With the uncertainty surrounding the EFSF’s Triple A rating was removed, the inaugural issue on behalf of Ireland surfaced at the beginning of 2011. The spread differential of the EFSF to other comparable issuers was arguably the main test for the leads of the five-year bond sold in January.
The transaction was handled by Citigroup, HSBC and SG CIB and carried initial guidance at mid-swaps plus 6bp–8bp which attracted more than 500 accounts into a stunning final book of €44.5bn. The final pricing of the issue was at mid-swaps plus 6bp and the issue went on to trade at minus 8bp in the secondary market as investors scrambled to top up their positions after the scaling back that inevitably resulted from such over-subscription.
“The strength of interest in the issue ensured that any structural questions that existed were dispelled and placed the EFSF at the pinnacle of the Triple A credit spectrum,” said Emmanuel Smiecench, syndicate official at SG CIB at the time.
PJ Bye, head of SSA syndicate at HSBC offered similar praise: “This proved to be a market defining deal, the like of which we may never see again. Over 500 institutional accounts showed their support with the order book reading like a ’Who’s who’ of the SSA investor base.”
The secondary levels of other European agency issuers were little affected by the appearance of the EFSF which, at the time, had planned to sell three benchmark issues totalling €16.5bn on behalf of Ireland and hence the inaugural deal certainly benefited from a rarity factor.
“It is clear that the EFSF was able to achieve a diversified investor base from its inception including a wide spectrum of asset managers as well as central bank accounts,” said Guy Reid, head of SSA DCM at UBS. “It was able to do this through a rigorous approach to marketing ahead of its inaugural deal and has subsequently been able to successfully build on those foundations which augers well for its future issuance,” he added.
Funding rises
After Portugal sought assistance in early 2011, the EFSF appeared in the markets again in June with another five-year deal as well as its first 10-year transaction. The latter attracted an order book made up of more than 100 accounts and was priced at mid-swaps plus 17bp by Barclays, Deutsche Bank and HSBC.
The transaction attracted €8bn of orders, considerably less than its inaugural trade, with Portugal receiving €3.7bn of the proceeds. Demand was somewhat less than the €13bn reached by the EU at the end of May for the €4.75bn 10-year part of its €9.5bn dual-tranche offering.
At the time a syndicate banker not involved with the deal said the level of demand showed the EFSF was now being treated more in line with other supranationals. “The novelty has clearly worn off and it is being treated as a normal name.”
Portugal received a further €2.2bn from the €3bn five-year deal sold at mid-swaps plus 6bp by BNP Paribas, Goldman Sachs and RBS. The final book size was in excess of €7bn and, as on previous occasions, about 20% of the distribution was accounted for by the Japanese Ministry of Finance.
Both of these deals widened in secondary trading, as did the spread of the inaugural transaction, as plans for the EFSF’s enlargement were drawn up, in part to reassure the market that it had sufficient capacity to deal with future potential needs.
“The plan to increase the EFSF’s guarantees from €440bn to €780bn will effectively increase its lending capacity to €440bn compared with about €255bn limit in its original format,” said Sean Taor, global head of public sector origination and syndicate at RBC CM. “Although subject to individual approval by all of the national governments, we expect that the changes will improve the ability of the EFSF to fulfil its objectives on a cost effective basis,” he added.
Currently Portugal is to receive up to €33bn and Ireland up to €27bn, leaving only €195bn at the EFSF’s disposal based on its original format, a factor which had concerned some market participants, particularly if either Italy or Spain were to require assistance.
SSA spreads impacted
While the reception to the EFSF’s first issue was widely seen as positive, the inaugural issue offered investors attractive terms to ensure a successful outcome in order to demonstrate the acceptance of the new issuer within the SSA sector.
The immediate effect was that spreads for other issuers were underpinned as the presence of another Triple A-rated issuer was seen as reinforcing the range of investors able to invest in the market as weaker rated sovereigns ceased to compete for funding.
The less generous terms offered by the EFSF for the five and 10-years in June, along with the perception that there was an increased possibility of other sovereigns needing assistance, saw spreads widen across the EFSF’s issues. At the beginning of September the spreads on the EFSF’s two five-year issues had both stabilised at around mid-swaps plus 9bp (compared with pricing at mid-swaps plus 6bp), while the 10-year deal sold at mid-swaps plus 17bp was closer to plus 23bp mid-market.
While it was expected that a deterioration of EFSF’s borrowing levels would impact on the wider market, the reality has been that German assets have outperformed other issuers while the EFSF’s funding levels have deteriorated.
The EFSF still has two issues left to sell this year on behalf of Ireland and Portugal, which will be for €3bn–€5bn each in size.
“In response to the eurozone debt crisis further measures involving the enhancement of the size and capital structure of the EFSF are being undertaken, although at present the main uncertainty surrounds the details of the next Greek rescue package,” said one syndicate banker.
The Greek debt crisis continues to cloud the outlook for the EFSF with some bankers suggesting that the only viable long term solution is the issuance of a euro bond on behalf of all eurozone states. The challenge this will present may ultimately be one of timing: can the legislative approval of national parliaments be reached before the European debt crisis spirals even further out of control?
Click here to see the Digital Edition of this report.
