There is broad disagreement among European banks on whether they should (and whether they will) choose to access the LTRO. We have discussed the top-down perspective and the very granular bank-by-bank perspective, and we end with a more bottoms-up perspective on the bank's own views of the LTRO. As SocGen notes, the investment banks (and certain Swedish banks) are very skeptical (and rightly so given the 'LTRO Stigma') while the Italian and Spanish are open to taking whatever they can, whenever they can (is that really a good sign?). Bank management must weigh the transparency they will face at the end of the quarter when sovereign bond holdings are exposed and just as SocGen points out, banks with considerably higher exposure (implicitly through the carry trade) may well face much more negative market action (even if Basel III doesn't handicap that risk). As with LTRO 1, the ECB will only reveal aggregate data, leaving the individual banks themselves to reveal their own take-up - we suspect the investment banks will make a point of highlighting that they did not take the funds, while the Portuguese, Italian, and Spanish banks will promote the benefits of their government-reach-around self-immolating ECB life-line.
Societe Generale: LTRO: Bottom-up analysis
The banks’ own views on the LTRO
We have carefully studied comments made by European banks on their views of the LTRO funds and looked for guidance as to their likely take-up in LTRO-2. Views among the banks range widely from those strongly in favour of tapping LTRO funds to engage in the carry trade (by buying sovereign bonds) to those vehemently opposed to using the funds. We have split the banks into four categories. The first group are those which have stated that they will not use LTRO-2; the second group expects to tap LTRO-2, but only to cover debt repayments falling due (be it in 2012 or beyond); a third group expects to tap LTRO-2 and engage in the carry trade by using the funds to purchase sovereign bonds; the final group was undecided or would not comment.
In most cases, banks commented in response to analyst questions at Q4 11 results announcements. The main exception to this is the Italian banks which have not yet reported Q4 11 results: for these, we use our expectation of what each bank will do.
Results are evenly distributed: among the banks expressing a view, around 30% will not take any funds, 40% will take LTRO-2 funds but only to cover maturing debt and the final 30% will use LTRO-2 funds to engage in the carry trade (buying sovereign bonds). However, 12 of 36 banks were either undecided or would not make any comments on their likely involvement in LTRO-2.
Those against – Barclays, CS, Deutsche, Natixis, SEB, SHB, UBS
The investment banks and Sweden’s SEB and SHB have stated that their respective institutions did not participate in the December LTRO and that they would not take any funds in this week’s LTRO auction. The banks refer to a very real stigma being attached to use of the funds, which could impact the reputation of their bank. It has also been commentated that the funds could retrospectively be considered government aid, which in turn could lead to state intervention, such as restrictions on distributions (dividends and bonuses). Deutsche also noted that its clients particularly value the fact that Deutsche has not touched such funds. SHB stated that they were "totally convinced" that the long-term benefit from staying away from LTRO funds is much bigger than the short-term P&L upside from participating.
Those in favour – Bankinter, all Italian banks
At the other end of the spectrum, we expect all five Italian banks under our coverage (Intesa, Unicredit, Popolare, MPS and UBI), Mediobanca and Bankinter to participate in the 28-29 February LTRO and to do so specifically in order to engage in the carry trade by buying sovereign bonds (in varying degrees). Bankinter stated at their Q4 11 results that they were "in the process of building out a specific portfolio of government bonds". Most Italian banks are yet to report Q4 results, and therefore typically have not made official comments, but it has been widely reported in the press that the banks are likely to engage in the carry trade to some degree.
Those in favour of the LTRO, but not the carry trade – Popular, Caixabank, DnB NOR, Bankia, BCP Millenium, Bank of Ireland, Commerzbank, Credit Agricole, RBS and Lloyds
A further ten banks are expected to tap LTRO-2 for funds, but only in order to cover maturing debt repayments, not to participate in carry trade activities. These include certain Portuguese and Spanish banks, but also a Nordic and Irish bank.
The undecided
A further 12 banks – almost half the sample – were undecided or would not comment on their likely LTRO-2 take-up.
Summary – SG view
There is a clear split in opinion amongst the European banks on the attractiveness of the ECB’s LTRO funds. The investment banks and certain Swedish banks view the funds with some scepticism, and have expressed concern over the stigma attached to the message banks are signalling by accepting these funds. Conversely, Italian banks in particular and Spanish banks to a lesser degree are open to taking the funds and engaging in the carry trade by buying sovereign bonds. Others banks, including the large Spanish banks, appear relatively open to tapping the LTRO funds for funding purposes, primarily to cover debt maturing in 2012, but will not engage in the carry trade.
We think a large number of the large quoted banks which are "undecided or would not comment" will fall into the latter category of tapping LTRO funds, but for funding purposes only, not for engaging in the carry trade. Banks report their holding of sovereign debt quarterly, and we believe that any bank reporting that it has made an extra €75m over one quarter by building an extra €10bn portfolio of Italian sovereign debt (based on a 3% yield differential for 3 months) is likely to be viewed negatively by the market, even in the current "risk-on" environment.
Finally, here is a brief cheatsheet from RanSquawk on the LTRO:
ECB PREVIEW: ECB's 3-yr LTRO on 29/02/12 at 1015GMT
- Estimates are clustered around a EUR 400-500bln allotment.
- The majority of analysts do not expect the ECB to conduct any further 3-yr operations.
- ECB expected to allot EUR 125bln in its 7-day operation, down on the previous EUR 166.5bln as banks utilise the 3-yr offering.
Given that the street expects that banks will tap in the region of EUR 400-500bln, together with the fact that banking stocks have a tendency to benefit from additional liquidity gives reason to believe that an adverse reaction will be observed in credit markets should the amount borrowed fall short of the consensus estimate. As a result, financials, which were the main beneficiaries of the program, will likely bear most of the brunt if equities were to react negatively to the announcement.
Mind the gap…
Love it or hate it, there is enough evidence to suggest that the decision by the ECB to provide 3-year loans avoided another catastrophic event in the financial markets. The first program, conducted back in December at the time when credit markets were trading at a rate last seen following the collapse of Lehman Brothers, saw 523 European banks borrow EUR 489bln. Even though it remains to be seen how long the euphoric mood will last, one cannot argue that conditions in the financial markets have improved markedly. So much so that the unsecured issuance which literally dried up in the end of the H2 2011 has picked up, while Fitch ratings agency noted in its recent research note that the US money market funds which slashed exposure to EU banks last year have increased their lending to the region in January, particularly to French banks. In addition to that, the fact that some of the funds were reinvested into sovereign debt auctions meant that Spanish and Italian bond yields are no longer at levels perceived as critical.
However, it is worth remembering that banks have around EUR 500bln of funding maturing this year, and although the first 3-year LTRO provided many of the struggling banks with an easy opportunity to fund themselves in the near-term, there is a risk that should conditions deteriorate once again (catalyst for which will likely be Greece and its looming March redemption) that access to credit markets will freeze once again. As such, even though estimates for the second 3-year LTRO have been