* Supply, ratings doubts weigh on EFSF/France credit spreads
* OAT/Bunds spread hits 118bp, euro record wide
* Investors dubious on EFSF, insurance plan questioned
By Michael Winfield
LONDON, Oct 21 (IFR) - The European Financial Stability
Facility's spreads have seemingly established a destructive
correlation with France, with the prospect of a beefed-up EFSF
hurting France's spreads and Triple A rating, and therefore the
The fact that investors are demanding fixed income assets
pay an attractive spread above French bonds has resulted in the
EFSF's outstanding EUR13bn of debt widening as well as impacting
other issuers such as the European Investment Bank and the
France's move this week to an all-time euro high of 120bp
over Germany has occurred as doubts over its ability to retain
its Triple A status have surfaced. Meanwhile, policymakers are
struggling to convince investors that the EFSF remains fit for
purpose, or what exactly that purpose is.
OAT spreads versus Bunds have doubled between the beginning
of July - when talks to upsize the EFSF's lending capability to
EUR440bn began - and end of September when they hit 72bp as a
result talks of the EFSF being leveraged to as much as EUR2trn.
A vicious circle has been created in which the widening of
either France or the EFSF is followed by the other weakening
This week's added 24bp widening in the OAT/Bund 10-year
spread has also been accompanied by the EFSF's secondary debt
widening in relation to Bunds by 32bp.
Investors in the inaugural and subsequent EFSF's deals are
nursing substantial losses. The five-year trades both sold at
mid-swaps plus 6bp - were quoted nearer to plus 70bp by the end
of the week, and the 10-year deal priced at plus 17bp, was in
the mid-80s over swaps.
Adding to the difficulties for the EFSF is that it is due to
be in the market as early as next week and is understood to
favour a 15-year transaction.
Potential investors require EFSF's new issuance terms to be
attractive compared to the French curve as many longer dated
investors are French insurance companies.
THE EFSF AS ESIM
Another twist is the potential for the EFSF to be able to
buy secondary debt, assuming a country is solvent and maintains
solid fiscal and current account targets, has a stable banking
system, and the ECB and deputy finance ministers agree.
A leaked document also suggested that the EFSF would have
the ability to sell bonds back into the market, hold to
maturity, sell back to the issuing sovereign or use them for
repo purposes with commercial banks.
Another idea on the table is the transformation the EFSF
into a new structure called the European Sovereign Insurance
But according to Tamara Burnell of M&G Investments in her
Bond Vigilantes' blog, "monoline insurers have a somewhat
tarnished track record in recent years [with] the fundamental
problem being persuading investors that they would ever be able
to call on the insurance policy provided by the EFSF/ESIM/ESM
when they actually need to," wrote Burnell.
RBS analysts think this approach has some logic, but the
effect of, "the insurance contract merely transfers the risk
into another part of the system and sometimes concentrates it in
dangerously high proportions."
At least there is a potential silver lining in proposals
that the EFSF insures sovereign debt, in that it would avoid the
necessity of pre-funding.
Uncertainty over how much EFSF paper is in the pipeline has
contributed to investors' fears, as well as growing unease about
its structure - especially in light of the leveraging proposals.
Leverage via an insurer model -- either the ESIM idea or the
BNP Paribas counterplan which would see it write CDS -- would
also seemingly deal with the question of Italy and Spain
potentially being in need of assistance though.
"Applying a leverage of five (a 20% first loss guarantee)
would imply covering maximum total issuance of EUR1.55trn of
sovereign debt [compared to] an estimate of Italy and Spain's
sovereign gross financing needs until Q2 2013 of around
EUR900bn," according to Citigroup.
Nevertheless, nine out of 10 fund managers and strategists
at firms running more than USD2.5trn in assets said they were
either unsure of or had no interest lending to the bailout fund,
according to a poll of asset managers conducted by Reuters this
And eight of 10 managers polled said they would not even
consider buying its bonds unless spreads were at least double
current levels of around mid-swaps plus 50bp-65bp. In addition,
three of those eight ruled out buying EFSF debt unless spreads
swelled beyond triple digits.
Jamie Stuttard, head of institutional bond portfolio
management at Fidelity in the UK suggested that despite the
plethora of different proposals being suggested this week ahead
of the fast approaching deadline, the main change that is needed
will take longer to achieve.
"In conjunction with a proper Greek restructuring, the EFSF
assuming an insurance roll and a feasible bank recapitalisation
plan, there is a need for a proper fiscal framework which will
need a reconciliation of the multiple different fiscal visions
Eurozone policymakers have," he said.
(Reporting by Michael Winfield, Editing by Alex Chambers)