Draghi’s $158 Billion Free Lunch for European Banks Seen Boosting Profits
Banks are benefiting from a European Central Bank subsidy that could reach 120 billion euros ($158 billion), enough to pay every bonus at financial firms in London for the next 24 years at today’s levels.
Royal Bank of Scotland Group Plc, BNP Paribas SA (BNP) and Societe Generale SA are among more than 500 banks that took 489 billion euros of three-year loans from the Frankfurt-based ECB at a December auction. The loans currently carry a 1 percent annual interest rate, less than a quarter of the 4.3 percent average yield on euro-denominated senior unsecured bank debt of all maturities in the past year, according to Commerzbank AG.
With borrowing estimated to hit a record 1.2 trillion euros after a second auction later this month, banks may save 120 billion euros over three years. That could boost 2012 profit by about 10 percent for lenders in Italy and Spain, according to estimates by Morgan Stanley.
“This is very much a free lunch,” said Arnd Schaefer, an economist at WestLB AG in Dusseldorf, Germany. “Banks can get money for just 1 percent and then lend it on for much more. That’s pretty good.”
The ECB is flooding the banking system with cheap money in a bid to avert a credit crunch after the market for unsecured bank debt seized up last year and funding from U.S. money markets disappeared. Any bank in the region can borrow an unlimited amount, provided it pledges eligible collateral. Lenders won’t face curbs on bonuses or dividends.
“The central bank has pumped the market with unbelievably cheap money because wholesale markets are closed,” said Richard Reid, director of research at lobby group International Centre for Financial Regulation in London and a former managing director at Citigroup Inc. “Stronger banks will inevitably profit, but that is a secondary issue for the ECB.”
Niels Buenemann, an ECB spokesman, declined to comment.
The Bloomberg Europe Banks and Financial Services Index rose 1.1 percent to 86.56 by 2:15 p.m. in London. RBS (RBS) rose 1 percent to 28.19 pence, while BNP Paribas slid 1.4 percent to 34.58 euros. The benchmark has rallied 20 percent since the ECB announced the first round of loans on Dec. 8.
Banks are required under rules approved by the Basel Committee on Banking Supervision to hold capital against any assets they pledge as collateral in exchange for the ECB loans, pushing the cost of participating above 1 percent, Guy Mandy, a London-based Nomura Holdings Inc. analyst, said in a Jan. 24 note. Assets are subject to so-called haircuts depending on how risky they’re perceived to be. That affects how much cash lenders will receive against the value of the assets.
A bank that pledges a book of loans with a five-year maturity subject to a 29 percent reduction in value would face an “all-in” cost of about 2.5 percent a year, Mandy said.
Lenders could take 680 billion euros of loans at the second auction on Feb. 29, according to a Goldman Sachs Group Inc. survey of investors published last week. That would raise total borrowings from the ECB’s longer-term refinancing operation, or LTRO, to a record 1.2 trillion euros, surpassing the $1.2 trillion in peak lending by the Federal Reserve to U.S. banks after Lehman Brothers Holdings Inc.’s 2008 collapse.
Banks including Morgan Stanley, JPMorgan Chase & Co. and Goldman Sachs reaped an estimated $13 billion by borrowing cheaply from the Fed and lending at a higher rate, according to data compiled by Bloomberg from central bank records of transactions obtained by court order and under the Freedom of Information Act. That figure, based on the lending margins of 190 banks that borrowed from the Fed, isn’t comparable to the estimate of the ECB subsidy.
“You are certainly going to get banks that don’t need the funds profiting,” said Richard Werner, an economist at the University of Southampton, England. “It would be much cheaper to target support for the 20 or so banks that need it, but politically the central bank wants to be seen to be neutral. It is a massive money-making opportunity for those who don’t need it to play the yield curve.”
European lenders are being encouraged by policy makers to use the ECB cash to purchase domestic sovereign debt, pushing down borrowing costs for governments and reducing the risk that one or more countries in the region default.
An Italian bank could borrow 1 billion euros from the ECB at 1 percent and use the proceeds to purchase three-year Italian bonds yielding about 3.60 percent. That so-called carry trade could boost income by 26 million euros a year.
Short-dated securities issued by southern European countries have rallied since the ECB announced the offer Dec. 8. Yields on two-year Spanish notes have fallen 229 basis points to 2.68 percent, while their Italian equivalents dropped 320 basis points to 2.95 percent. A basis point is 0.01 percentage point.
Longer-dated securities underperformed shorter-duration notes on concern that austerity plans won’t plug deficits and reduce Europe’s debt load. Ten-year Spanish bond yields have fallen 95 basis points to 5.17 percent, while their Italian counterparts have dropped 146 basis points to 5.46 percent.
“In many ways this has been a masterstroke,” said Charles Goodhart, a London School of Economics professor and a former Bank of England policy maker. “People have been asking the ECB to implement quantitative easing on a large scale without invoking the wrath of the Germans and provoking statements about helping undeserving southern Europeans. This is it.”
Some banks, rather than heed calls by politicians to boost lending to companies and consumers, are choosing to deposit the money in the ECB’s overnight facility at a rate of 0.25 percent until they need it to refinance maturing debt. While that’s costing them 0.75 percent, it’s still a saving on the potential expense of issuing bonds to private investors.
Euro-area banks need to refinance more than 600 billion euros of debt maturing in 2012, the Bank of England said in its December financial-stability report.
Just 4 percent of investors polled by Goldman Sachs said they thought the proceeds would be used to increase lending to customers, compared with 56 percent who said it would be used to refinance maturing debt and 26 percent who said it would be invested in sovereign bonds.
Deposits with the central bank rose to a record 528 billion euros on Jan. 17 and were at 508 billion euros at the end of last week, according to ECB data released today. European lenders deposited an average of about 280 million euros with the ECB in the eight years before Lehman’s collapse.
Banks also are cutting lending outside their home markets, data compiled by the Bank for International Settlements show. Euro-area banks reduced lending to Asia by 9 percent and to central and Eastern Europe by 8 percent in the third quarter.
“Since the LTRO is an ECB operation, it is reasonable to expect the funds created to be used in a way that benefits the public,” Greg Ford, a London-based spokesman for lobby group Finance Watch, said in an e-mail. “One way to ensure this is to insist that banks retain the profits they make from the LTRO carry trade to build higher capital reserves.”
The 489 billion euros borrowed from the ECB in December exceeded economists’ median estimate by 66 percent. Demand may be higher at the second auction because any stigma associated with using the facility has dissipated and the list of assets banks can pledge as collateral for the loans has widened, according to William Porter, an analyst for Credit Suisse Group AG in London.
The ECB is encouraging all banks to participate in the second auction.
“There is no stigma whatsoever on these facilities,” ECB President Mario Draghi said in Frankfurt on Feb. 9. “The use of these proceeds is a business decision. Our primary interest is in lending to the real economy.”
If total borrowing from the two auctions hits 1.2 trillion euros, banks will pay about 12 billion euros a year in interest at the current benchmark rate of 1 percent. The same amount borrowed in the senior unsecured bond market would cost about 52 billion euros a year, based on Commerzbank data showing a 4.3 percent average yield on such debt over the past 12 months. That represents a saving of 120 billion euros over three years.
Bank bonuses in the City of London will be about 5.1 billion euros for 2011, according to the Centre for Economic and Business Research.
The ECB can’t limit the loans to particular banks because that would risk violating European Union state-aid rules, said Neil Smith, an analyst at WestLB.
“If the ECB started singling out individual banks for special treatment, you could be getting into complicated competitive distortion issues,” Smith said.
RBS, which received 45.5 billion pounds ($72 billion) in a U.K. government rescue at the height of the financial crisis, borrowed 5 billion pounds from the ECB in December, a person with knowledge of the matter said. It will pay interest of 50 million pounds a year compared with 215 million pounds if it had borrowed at the average yield on senior unsecured bank debt denominated in euros in the past year. That represents a saving of 495 million pounds over the three-year life of the loan.
Linda Harper, a banks spokeswoman, declined to comment.
Intesa Sanpaolo SpA (ISP), Italy’s second-biggest bank, took 12 billion euros from the ECB in December and expects to participate in the February auction, Chief Executive Officer Enrico Tommaso Cucchiani, 61, told reporters in Milan on Feb. 7. The loans were “essential for some banks” and “useful for other banks, including Intesa,” Cucchiani said.
UniCredit SpA (UCG), Italy’s biggest bank, borrowed 12.5 billion euros from the ECB, while Banca Monte dei Paschi di Siena SpA got 10 billion euros, according to a Jan. 18 Morgan Stanley note based on conversations with the lenders. The ECB funds may increase Italian banks’ earnings by as much as 10 percent this year and 30 percent in 2013, according to Morgan Stanley.
Banco Bilbao Vizcaya Argentaria SA (BBVA), Spain’s second-biggest lender, said it borrowed 11 billion euros in December. No decision has been reached on whether it will participate in the February auction, Paul Tobin, a spokesman for the bank, said.
Madrid-based Banco Popular Espanol SA took 8.5 billion euros at the LTRO, taking their total loans from the ECB to about 30 billion euros, Chief Financial Officer Jacobo Gonzalez- Robatto said on Feb. 1. Bankinter SA (BKT) borrowed 5 billion euros, according to Morgan Stanley.
The loans could boost operating profit before provisions at Spanish lenders by 6 percent to 12 percent, Morgan Stanley said.
French banks didn’t disclose how much they borrowed in the first auction. The LTRO will enable Societe Generale (GLE), BNP Paribas and Credit Agricole SA (ACA) to cover their borrowing needs for 2012 -- a combined 47 billion euros -- and boost profit, according to a Jan. 27 note from Delphine Lee, an analyst at JPMorgan in Paris.
Spokesmen for Credit Agricole, Societe Generale, BNP Paribas and UniCredit declined to comment. Bankinter and Banca Monte dei Paschi didn’t return calls seeking comment.
Since the ECB announced its long-term lending program, yields on European bank debt have tumbled and the market for senior unsecured debt has reopened. BBVA sold 2 billion euros of 18-month notes on Feb. 7 yielding 3.1 percent or 193 basis points more than the mid-swap rate.
Intesa sold 1.5 billion euros of 18-month senior unsecured bonds last month with a yield of about 4.1 percent or 295 basis points more than the mid-swap rate. Lloyds Banking Group Plc (LLOY), based in London, raised 1.5 billion euros from a five-year offering Jan. 26. It priced the bonds to yield 4.1 percent or 305 basis points more than the benchmark swap rate.
“This is an attempt to solve a crisis and bring about financial stability.” Goodhart said. “If one of the side effects is some jam on top for a handful of well-run firms, that is a small price to pay.”
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