Market Outlook - BNP PARIBAS - Investment Services India

This section is classified as non-objective researchEUR: EFSF Leverage in Focus• The idea of leveraging the EFSF throughguarantees on first losses of newly issuedsovereign debt is gaining ground. We explainand illustrate such a proposal.• On the positive side, this type of leveragewould ease the funding needs of the EFSF,thereby decreasing issuance expectations.• Together with the planned use of short-termfunding and upcoming details on the financingof the aid to Greece and financing of thedefeasance assets, issuance expectations haveroom to fall significantly in the short term.• We therefore see a non-negligible chance ofa tightening in spreads that we recommendpositioning for through a protected RV trade:sell CADES 10y, buy EFSF 10y.As discussions on a leverage of the EFSF throughguarantees of newly issued sovereign debt havegained momentum over the past few days (andtherefore looks increasingly likely), we explain such aproposal and look at potential effects.Leverage through guarantees on first losses of aportion of newly issued sovereign bondsUnder that proposal, the EFSF would insure the firstportion of losses (a given percentage of the bondissued) in the event of a sovereign default. Accordingto the headlines, the EFSF would guarantee between20% and 30% of the bonds newly issued bystruggling euro area governments, for example Spainand Italy. The smaller the percentage of guarantee,the higher the leverage, as the amount of debtcovered is more significant. For instance, numerousreports have stated that, by guaranteeing the first20% to 30% of any losses, the EFSF could leverage3 to 5 times its original size. Indeed, EUR 780bnguarantee commitments used to insure the first 20%or 30% losses would cover, respectively, EUR 3.9trnor EUR 2.6trn debt (780/0.2 or 780/0.3) therebystretching the original size of the EFSF by 3 to 5times (3900/780 or 2600/780).This idea was originally brought up by Sony Kapoor(advisor to governments and internationalorganisations) in September 2010 in Euro AreaGovernance – Ideas for Crisis Management Reform,when he suggested “the EFSM/EFSF should provideguarantees not loans”. In January 2011, he reiteratedhis view in Building a Comprehensive CrisisTable 1: EFSF – Remaining Lending Capacity vs.Remaining Guarantee CommitmentsEFSFLending CapacityGuaranteeCommitmentsAnnounced EUR 440bn EUR 780bnActual EUR 440bn EUR 726.2bnAlready Committed EUR 185.6bn EUR 306.2bnRemaining (still atdisposal)FinancingProgrammesEUR 254.4bnGuarantee Amounts(to be) CommittedEUR 420bnLoans AlreadyDisbursedIreland EUR 17.7bn EUR 29.2bn EUR 3.6bnPortugal EUR 26bn EUR 42.8bn EUR 5.9bnGreeceEUR 141.9 (incl. EUR32.9bn from bilateralloans)EUR 234.1bn -Total EUR 185.6bn EUR 306.2bn EUR 9.5bnSource: BNP ParibasTable 2: EFSF – Expected IssuancePROGRAMMES TOTAL ISSUANCE Q4 2011 AFTER 2011IRE/PORGREECEEUR 47.2bn(BNPP estimate)Up to EUR 141.9bnEUR 3bnEUR 44.2bn(BNPP estimate)> Existing facility [0; EUR 32.9bn] [0; EUR 9.4bn] [0; EUR 23.5bn]> Second program Up to EUR 109bn [0; EUR 65bn]Source: BNP ParibasQ4: [EUR 3bn;EUR 77.4bn]Remaining of EUR109bnManagement Framework for the EU andExtinguishing the Raging Fire: “a much more efficientuse of the balance sheet of the EFSF would havebeen to guarantee new bond issues by troubledMember States … this would have the instantaneouseffect of 1) restoring capital market access fortroubled Member States, 2) significantly lowering theborrowing costs they face, and 3) more than doublingthe effective size of the EFSF to more than EUR500bn" (at that time, the EFSF lending capacity wascapped at EUR 250bn). At that moment, SonyKapoor recommended guarantees against the first40% of losses, based on expected losses factored inby the market on Greek and Irish debt.Note that this recommendation was consideredtogether with other options for expanding the EFSF’sCamille de Courcel 20 October 2011Market Mover30www.GlobalMarkets.bnpparibas.com