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By Philip Wright and Julian Baker
LONDON, Aug 8 (IFR) - With talk of the size of the European Financial Stability Facility’s lending capacity being increased from its current but yet to be ratified EUR440bn - numbers such as EUR1trn, EUR2trn, even EUR4trn, have been bandied around - one thing is clear: there is likely to be a lot more paper in the market than was envisaged when the limit was EUR250bn.
The EFSF has priced three benchmarks so far this year for a total of ?13bn and spreads on all of them have come under pressure in anticipation of potentially increased supply.
After a euphoric debut in January - with a record-breaking oversubscription level of EUR45bn of demand for EUR5bn of bonds - and two significantly less impressive but nevertheless respectable follow-up deals in June, all three issues are now trading wide of their respective pricing levels on a mid-swap basis. They have also notably underperformed European Union bonds with a comparable maturity.
The most recent EUR3bn five-year offering was priced on June 22 just over 1bp behind the EU curve and is currently trading about 6bp behind. Meanwhile, a EUR5bn 10-year deal that was priced a week earlier at 2.5bp over EU reference points is currently at plus 10bp.
But all this could pale into insignificance were it necessary to increase the EFSF’s lending capacity to take into account the possible needs of larger eurozone sovereigns, such as Italy or Spain.
Those worrying about such an increase seized on a letter sent by European Commission President Jose Manuel Barroso to EU leaders last week, in which he said: “I...urge a rapid re-assessment of all elements related to the EFSF, and concomitantly the ESM [the European Stability Mechanism], in order to ensure that they are equipped with the means for dealing with contagious risk.” Those elements, many reasoned, included size.
Greek needs add pressure
Even without any further increase in the EFSF’s lending capacity, the second Greek bail-out could push its funding needs to as much as EUR65.1bn for the rest of the year (from the previously earmarked EUR19bn), according to analysts at Barclays Capital.
Bankers away from Barclays questioned the top-end figure, however. “We don’t think all the issuance will come through the markets, but we cannot say for sure,” said a senior DCM official at a rival bank.
“What we do know is that changes to the EFSF need parliamentary consent first and that won’t happen until after the summer, maybe late September or October, so to start talking about potential issuance levels for the coming quarter I think is largely meaningless.”
His comments were echoed elsewhere. “There are all sorts of different numbers to factor in here and there are too many unknowns at the moment,” said an SSA syndicate official. “I don’t see the point of jumping the gun with a scary-looking forecast just to impress your clients.”
The overall size of the EFSF will be increased to EUR780bn to facilitate the EUR440bn number and, in addition, each country’s over-guarantee ratios will be set at 165%, up from the current 120%. That means that “the EFSF will no longer need any loan-specific buffer to protect the Triple A rating of its bonds”, pointed out RBS analysts.
Under the existing system, the rating agencies demand that the EFSF provides additional Triple A collateral for the proportion of each EFSF bond not guaranteed by Triple A rated countries.
The share of the six Triple A rated eurozone countries (Germany, France, the Netherlands, Austria, Finland and Luxembourg) amounts to 62.4%. Given the 120% ratio, almost three-quarters of each bond issue currently benefit from Triple A guarantees but at 165% that would rise to 102.9%.
Existing bonds and any sold before the new proposals are ratified will continue to require a loan-specific barrier. Those issued thereafter, however, will be completely guaranteed by Triple A rated sovereigns, something that could lead to a two-tier market, although which structure would be preferable is a moot point.
The spread of 10-year OATs over Bunds has already gapped out to its widest level since mid-1990. Seemingly, what the market now views as core Europe is increasingly centred on Germany with confidence in some of the sovereigns currently rated Triple A not necessarily that robust.
Germany’s contribution to the EFSF rises to 29% from 27% under the new proposals, while France’s grows to 22% from 20.5%. These swell to 43% and 32% if Italy and Spain withdraw. (Reporting by Philip Wright and Julian Baker)