Banks’ LTRO Repayments to Underline Two-Tier Europe: Euro CreditJohn Glover
Lenders repaying cash borrowed from the European Central Bank via its Longer-Term Refinancing Operations are poised to underline the north-south divide that characterizes the euro region.
Banks can start paying back this week more than 1 trillion euros ($1.33 trillion) of three-year money they borrowed in two portions during 2012. Only banks able to raise funds at less than the 75 basis points the ECB charges are likely to repay, and they will probably be from northern Europe, said Richard McGuire, a strategist at Rabobank International in London.
“If it turns out the repayments come from the core banks only, then that’s a negative,” McGuire said. “It shows there’s still a two-tier euro zone. The tension is still there.”
The ECB’s LTRO programs in December 2011 and February 2012 reduced the risk of a systemic crisis blowing the single currency apart. Along with ECB President Mario Draghi’s July pledge to do “whatever it takes” to preserve the euro, the cash infusions helped stem a rout in Spanish and Italian bonds.
Between 200 billion euros and 250 billion euros are likely to be repaid “and we aren’t expecting many peripheral banks to take part,” said Derek Hynes, who helps manage $9.5 billion at ECM Asset Management Ltd. in London. “They have some market access now, but they’ll need three to six months to gain the confidence to hand back the money.”
The prospect of money flowing back to the ECB has driven up interest rates in the futures market. The rate on three-month euro futures expiring in December 2013 rose as high as 0.54 percent on Jan. 18, the most since July and up from 0.25 percent at the start of the year. The two-year interest-rate swap cost has climbed to 55.2 basis points from 38 at the end of November.
The LTROs swelled the ECB balance sheet to 2.94 trillion euros, up from about 2.5 trillion euros on Dec. 16. While a reversal of that as banks repay is “a major milestone,” it may produce “stealth” interest rate increases, George Saravelos, a strategist at Deutsche Bank AG in London, said in a report.
The yield on two-year German notes increased to as high as 24 basis points on Jan. 17 from minus 1.5 basis points at the beginning of the year. The rate is now 17.4 basis points.
Banks can now repay their borrowings at weekly intervals. The ECB is expected to publish the number of companies repaying and the amount returned tomorrow, with national central bank accounts revealing later which countries reimbursed LTRO cash.
For stronger banks in northern Europe, the usefulness of the LTRO cash has largely ended, said Don Smith, a London-based economist at ICAP Plc, the biggest broker of transactions between banks.
“When the LTRO was put in place, it was a phenomenally good deal for the banks,” he said. “They could get funding at much cheaper rates than in the market, for longer maturities and in size. Now, ECB funding is relatively much more expensive than it was and that argues for repayment.”
Stronger banks can issue three-year senior unsecured bonds at a cost that’s “broadly similar to borrowing from the ECB,” said Steve Hussey, a credit analyst at AllianceBernstein Ltd. in London, which manages $430 billion. “Either they’ll refinance their borrowing or the growth opportunities aren’t there and they’ll shrink their balance sheets. Either way, borrowing from the ECB and leaving it on deposit at zero percent is losing them money.”
A one-year repurchase agreement, or repo, with Italian government bonds as collateral, costs about 22 basis points, according to Smith at ICAP. A three-month repo using ECB-eligible collateral rated A costs 10 basis points, he said.
Spanish and Italian banks took about 334 billion euros of the 532 billion euros of LTRO borrowing disclosed by the banks and tracked by Bloomberg. Cash was parked in government securities, helping to support bond markets as suggested at the time by France’s then-President Nicolas Sarkozy.
“To the extent that the repayments are a sign of continued, very significant reliance on the ECB, that’s a negative,” said Smith at ICAP. “In terms of vulnerability to a re-escalation of the crisis, the Spanish and Italians are very exposed.”
Italy’s three-year notes yield about 2.04 percent, down from a high of 6.32 percent at the beginning of 2012. Spain’s three-year yield is down to 2.83 percent from more than 7.4 percent six months ago.
“When the LTROs started, the peripheral banks took as much as they could as an insurance policy,” said Andrea Cicione, a strategist at Lombard Street Research Ltd. in London. For those companies, “any alternative to the LTROs is likely to be more expensive,” he said.