With all eyes on the eurozone sovereign debt crisis, the success of two consecutive offerings would be critical in underpinning the European response. The market's reaction to the issues from the European Financial Stability Mechanism and European Financial Stability Facility was conclusive. Only one bank, HSBC, worked on both of them.

It was a once-in-a-lifetime transaction, according to one banker. Another said he felt privileged to have been involved in it. The avalanche of response to the first issue from the European Financial Stability Facility (EFSF) dwarfed even the bumper order book for the European Financial Stability Mechanism (EFSM) fundraising that preceded it (see Issuer Strategy in the February issue). Only one bank enjoyed the distinction of working on both deals, and that was HSBC.

These transactions have transformed the atmosphere in the markets for eurozone sovereign, supranational and agency (SSA) bonds. Most of 2010 was clouded by concerns over the peripheral eurozone economies, starting with Greece, moving on to Ireland, Portugal and Spain, and ending with worries over the future of the euro itself. The EFSM and the EFSF, together with the International Monetary Fund, form the backbone of the EU’s response to the crisis. But as last year came to an unlamented end, no one was certain that its rescue package would actually work and restore some confidence to a shaky market.

Coming to the rescue

The EFSM is an extension of the EU’s balance of payments programme, drawn up to help non-eurozone member states solve their balance-of-payments problems. To that end, the EU has been coming to the capital markets since the end of 2008, raising debt to support countries such as Hungary, Latvia and Romania. The EFSM widens that programme to include eurozone members, and it was on its behalf that the EU returned to market in the first week of January to raise €5bn in five-year paper, destined to fund loans to Ireland.

This inaugural EFSM transaction was announced a couple of days before the Christmas break, so that no one could accuse the EU of a lack of transparency and to give investors time to mull it over. It also positioned the deal to get off the mark as early as possible in January. The joint bookrunners were Barclays Capital, BNP Paribas, Deutsche Bank and HSBC, which was also the sole duration manager, as it would be on the EFSF deal.

“The mood at the end of 2010 was gloomy,” says Frédéric Gabizon, HSBC's head of sovereign debt capital markets (DCM). “So, while the EFSM deal was expected by the market, it was a test of how the rescue package would be welcomed – or not – by investors.” 

With the EU as the borrower, the issue is ultimately backed by the guarantees of its 27 member states. Insofar as the EFSM was only a new name for a familiar funding exercise, the main challenge was the step up in size from earlier support-related issues, which tended to be in the €1bn to €2bn ballpark.

Since the previous year had closed on such a gloomy note, the EFSM order books did not open with unbounded confidence in the first week of January. The mooted 10-year tenor was reduced to five at Ireland’s request, and price guidance was 12 basis points (bps) to 15bps over mid-swaps. The investor response was heartening, and such was the influx of orders (more than €20bn) that they were closed again 45 minutes later. The issue was finally priced at the tight end of guidance. A month later, it was trading at a sensational -11bps. 

A different creature

The EFSF issue was launched almost but not quite on its heels, in the last week of January. This is a different creature. Its job is to raise capital market funds for any eurozone member that cannot finance itself at a sustainable rate. Its paper is overguaranteed (to the tune of 120%) by all eurozone member states on a pro-rata basis, with two exceptions – Ireland, for whom the funds are being raised, and Greece. “When a state becomes an EFSF beneficiary, like Ireland, it steps out as a guarantor,” explains Mr Gabizon. Ironically, the more countries that step out, the stronger the AAA rating becomes.

Because it was a completely new name in the market, selling the EFSF was altogether a bigger task, and the selection of the joint bookrunners was correspondingly more painstaking. Shortlisted banks had to turn up in Frankfurt for two days of interviews with officials from EFSF and Deutsche Finanzagentur (the German government debt issuance agent), and the winners of this unusual beauty parade were Citi, Société Générale and, once again, HSBC. 

“We have experience in bringing similar new names to market, such as SFEF and FROB [Société de Financement de l'Economie Française and Fondo de Reestructuración Ordenada Bancaria, the French and Spanish financial support agencies],” says Christophe Sarragozi, an HSBC associate director in DCM for Europe, the Middle East and Africa. The bank has also been the leading player in the eight EU benchmark issues since late 2008, acting as bookrunner on four of them with a market share of 16.3%, just ahead of Deutsche Bank.

Market lift

The EFSM deal restored the market’s poise, for purely psychological reasons. None of the macroeconomic facts on the ground had changed, but there was a new spring in the market’s step. SSA spreads have been generally tightening in sympathy and subsequent issuers have been able to fund at tighter levels. That was a great help to the EFSF deal.

“The timing was right,” confirms PJ Bye, HSBC’s head of public sector syndicate, pointing to the way the market mindset swings between ‘risk on’ and ‘risk off’. “At the back end of 2010, the market was too negative, given the fundamentals of Europe. This year, it has swung in the other direction. The EFSM deal helped, but there is also the fact that cash is available,” he says. 

Mr Bye adds that the marketing effort for EFSF was “enormous”, as the bookrunners reached out to all investors who had ever bought EU or major eurozone sovereign paper, persuading them to put lines in place and discussing the merits of pricing. The marketing was especially international in scope and ambition, and got a boost from governments that really wanted the rescue package to work. There was some unusually strong public support from Asia. Japan's finance minister announced that his country was thinking about buying “more than 20% of the issue” – giving onlookers a rare peek behind the curtain of public finances. 

This was just the kind of committed investor the team needed to appeal to its core audience of central banks and sovereign wealth funds. But the investor net spread much wider and hauled in some – such as European insurance companies and pension funds – who had not participated in the EFSM deal because they prefer longer maturities. “The EFSM blowout was so massive that investors wanted to participate in EFSF, even though it wasn’t the type of asset they normally invest in,” says Mr Gabizon.

Biggest of all time

Like EFSM, the EFSF’s was a five-year issue looking to raise €5bn. Of that, €3.3bn would be passed through in loans to Ireland, with the rest held as a liquidity and cash buffer. As a weaker credit than the EU, it pays a higher coupon – 2.75% compared with 2.5%. The books opened with price guidance of mid-swaps plus 6bps to 8bps. They stayed open for a mere 15 minutes, as orders worth an extraordinary €44.5bn poured in from more than 500 investors. That is the biggest order book of all time, and one rival banker said he was not sure he could even think of 500 investors.

The price was fixed at 6bps over, and the bonds were trading at -3bps a week later. There were many inflated orders and allocation was draconian, except for those going to Japan. But the distribution demonstrated an international vote of confidence in the rescue package, with 38% going to Asia (including the 20%-plus Japanese allocation). North America took a teeny 2%, since the issue was not eligible for Rule 144 exemption (thus restricting sales), although exemption is planned for future issues. “The EU can’t issue in dollars, but the EFSF can and has said that it will, later in 2011,” Mr Gabizon says. “The expectation for an EFSF blowout in dollars is quite promising.”

The outlook for EU rescue package funding in general is equally promising, he adds. EFSM funding for Ireland in 2011 could total €17.5bn, with another €1.5bn needed for the Romanian support programme. The EFSF hopes to raise up to €16.5bn this year and a potential €10bn in 2012. Demand for the EFSF's AAA paper will be helped by the fact that European sovereign issuance volumes will be down this year, based on their budgets, and by a large wave of redemptions from SFEF and government-guaranteed banks between now and 2013.

“Investors now know that there is a backstop and that it works,” says Mr Gabizon. “That’s very promising for future rescue package transactions and for the rest of Europe’s sovereign borrowers.”

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