Europe's tale of two rescue funds is morphing into a worrying saga.
The outlook for the region's original crisis bailout vehicle, the European Financial Stability Fund, to raise sufficient long-term funds to do its job is getting trickier.
Despite last week being a pretty decent one for bond issuance, the EFSF stayed on the sidelines. Meanwhile, its more-popular sister fund, the European Stability Mechanism, easily funded in 10 years, raising 3 billion euros with an order book more than double that. It's a far cry from the EFSF's venture last month, which Gadfly pointed out was notable for a troubling lack of enthusiasm for its 39-year issue.
Furthermore, its spread to the ESM is widening, and analysts at NatWest Markets expect it to widen further. Where once the spread between the two was pretty tight, that's now increasing as the fundamental differences between the credits are starting to show. It's hard to see what will reverse that trend.
The ESM is a better credit. It has actual paid-in capital of 80.7 billion euros, whereas the EFSF has just 30 million euros and relies solely on guarantees from euro-area countries. This means if any of the EFSF's loans or investments were to take a loss there would have to be an actual capital call -- imagine how that would go down in election season.
The EFSF is shuttered to new loans, whereas the ESM is there for any future contingencies as well. Unfortunately for the EFSF, this means it's lumbered largely with the first two Greek bailouts, having 130 billion euros extended to Greece out of its 170 billion euro loan book. No prize here for being the first mover.
The ESM also has wider and better credit-quality exposure, including Spanish banks that are faring much better than Greek banks. Crucially, though, it has more than enough capital to cover its 72.7 billion-euro total loan book. That's money good in any event.
The Greek banking system's rescue includes a free option to switch their floating-rate debts to borrowing fixed 30 at years or more. This leaves the bailout funds with serious exposure both to a steepening yield curve. Any higher funding costs get passed on to the Greek banks that can ill afford it.
None of this is promising for the EFSF's ability to match-fund its exposures. It's raised 25 percent of its 40 billion euro funding target for the year -- from that perspective, it's broadly on track. But just 2.5 billion euros of that was in bonds longer than five years.
The ESM also has long-term liabilities, but these cover a range of peripheral countries and the share of Greek exposure is smaller. And it's raised 38 percent of its 17 billion-euro funding target in 2017, at 10-year and 29-year maturities.
While there is strong demand for the EFSF’s shorter-term debt, it's not clear when they'll be able to raise money, in any meaningful size, longer than 10 years. The capital markets for ultra-long debt have effectively closed in Europe probably now until the results of the French election.
The near-term prospects for the long-bond market aren't good, but it could come back, particularly on a victory by Emmanuel Macron in the French election. Even so, the EFSF will have to fight for airtime as the other issuers that have been shut out will be piling in. That is not good for their spreads, especially as the market knows it will have to be a repeat issuer.
One solution would be to mash the two credits together and take the strain off the weaker EFSF brand -- but nothing in the European Union's vast bureaucracy is ever that easy. Nonetheless, this should be given some serious thought.
Were it to encounter serious difficulties in meeting its funding requirements, that raises the prospect of it struggling to deliver its commitment to the Greek banks, and that is unthinkable. Even if that may be a long way off, better to prevent a crisis than fight to contain the mess.
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