EFSF falls victim to volatility and uncertainty

Wed Nov 2, 2011 11:08am EDT

LONDON, Nov 2 (IFR) - High execution risk and concerns about its mission forced the European Financial Stability Facility (EFSF) to put on hold plans to issue a EUR3bn maximum long 10-year deal on Wednesday.

The issuer had mandated Barclays Capital, Credit Agricole and JP Morgan on Monday and expectations were that it would go ahead with a trade today. However, the announcement late on Monday by Greece's prime minister George Papandreou to call for a referendum on the latest EU aid deal sent markets in a downward spiral on Tuesday morning.

Meanwhile, investors continue to be concerned about the structure of the euro zone rescue fund and its funding needs.

Yesterday, credit markets saw one of the biggest one day widening moves since the crisis began, with Crossover 90bp wider to 750bp at one stage having traded down to 610bp on Friday morning. Bunds rallied by three points, one of the biggest ever one day moves on the contract.

Conditions are still volatile today with the Bund future down 80 ticks and 10-year France trading Euro era wides of 130bp, not far off the lifetime wide of 140bp set back in 1992.

Meanwhile, EFSF's spreads also came under pressure with the outstanding 10-year moving from 75bp on Monday to 90bp today, more than 70bp wider than when the deal was priced in June.

"We mandated the deal on Monday so that we would be in position to do a deal today if market conditions permitted but given market conditions, we decided not to proceed given the market backdrop and the fact that we knew we had some time," said Christophe Frankel, CFO and Deputy CEO of EFSF.

"As far as signalling is concerned, what would have been taken negatively by the market is if we did not have flexibility and were under constraint to issue at any precise date."

The issuer and the lead managers held an investor call at 9.30 this morning and decided not to proceed afterwards.

"We were always planning to hold a call in order to update investors as we felt it would be useful but didn't want to do it earlier because of the holidays on the continent on Monday and Tuesday," said Frankel. "This is what we have done for two of our previous deals."

Market participants yesterday warned that any deal was going to be difficult to execute .

The proceeds of the bond are for Ireland's bail-out package. According to Tradeweb, Ireland has EUR4.39bn redeeming on November 11.

"I don't know if Ireland absolutely needs this amount, they need a tranche of the programme and this should be done by November," said Frankel. "Our main funding capacity is the bond market but we have different ways to provide funds to Ireland if needed."

A spokesman for Ireland's debt office said the country had sufficient reserves to cover the redemption .

TOO MUCH UNCERTAINTY But while market conditions can be blamed for the delay, how much EFSF is going to have to fund and what shape the fund will take have been at the forefront of investors' minds.

The agreement last week by European authorities to leverage the fund or use it as an insurance vehicle was the latest installment in a saga which has seen the EFSF grow in size and change in shape.

"Investors want to understand the new EFSF, the new guarantee, they want to know our funding programme for the rest of the year and what we can say about the latest two instruments that are being considered regarding participation and leverage," said Frankel.

"While we have quite a clear view on Ireland, it is less obvious for Portugal. They don't need any more money this year and can wait but if the market is good, we could do a deal this year. As far as the Greek programme is concerned, it's too soon to be able to say."

For bankers, this is one of the main problems. "The market need a deal to work and for that, EFSF needs real money investors," said a head of frequent borrower DCM. "Right now, investors don't know what its funding needs are, they don't have clarity on its mission and what EFSF's broader structure is. The EFSF needs to be able to provide these answers."

Frankel added that he understood investors' concerns. "At the same time, we are a crisis resolution mechanism and we operate in an uncertain environment," he said.

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He was keen to emphasise EFSF's quality as a credit. "The quality of our paper is very clear and not a concern," he said. "We are backed by six Triple A rated countries and this is well understood by the market. It is not because we have a new mission that we will need to borrow more and the size of our programme is capped. If you look at the leverage instrument, it will probably not increase our funding programme and it is highly probably that the bonds that could be used as protection will not be funded through the markets. We try to explain this to investors, although nothing is definitive today."

Frankel hopes that the EFSF will be able to revive its issuance plans in the near future. "We don't have a precise date and we want to target a time when the markets have calmed down," he said. "We have the G20 in two days which could bring back some serenity to the market."

However, one banker said an ECOFIN meeting at the beginning of next week could cause delay while markets wait to see if more details come out of it.

Frankel said that the recent spread underperformance would not necessarily hurt EFSF's prospects. "A very important part of our investor base is buy and hold and mostly insensitive to mark to market and for some, they will be more than happy to buy high quality paper with a spread."

RIGHT DECISION SSA bankers away from the deal said delaying the trade was the right decision given the market backdrop. "It was absolutely the right decision," said a head of SSA DCM. "It was good that they did not try to force a deal. Having said that, I don't think they had a choice and I don't think real money investors would have stepped in to buy the deal and the leads would have been left with EUR1bn each."

Another senior SSA banker echoed this view. "The feedback we have had from investors is that they are glad that they were not being pushed," he said. "The problem for investors is that it is very difficult for them to know what they are buying and they don't know what the supply will be."

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