Arbing The Record Euribor-Libor Spread, Or Is There More To Liquidity "Moderation" Than Meets The Eye
As liquidity conditions in Europe continue being tight to say the least, an interesting arbitrage has emerged in the market for wholesale Euro deposit term markets, i.e., EUR Libor and Euribor. Even as EUR 3M Libor has stabilized recently, the same cannot be said for its European Banking Federation cousin, Euribor. While the two metrics should ideally converge, the dispersion between the two is now back to all time record levels, with EUR Libor at 90% the rate of Euribor. One might be tempted to say that due to the Euribor panel consisting of almost 3 times as many banks (42) as that of the BBA's Libor, and also due to a far less aggressive outlier trim (BBA removes top and bottom quartile, EBF cuts out the top and bottom 15%), Euribor is far better indicator of cash stress. To be sure, there are marginal structural differences between Libor and Euribor: the first is a submission of perceived cash offers in the interbank markets present to a BBA member bank by other parties, and thus tends to always be rosier, as no bank is willing to indicate that others potentially see it as a counterparty risk, demanding a higher funding rate. Euribor, on the other hand, indicates where the bank itself will offer cash, and thus provides far less fudging opportunities. Nonetheless, traditionally these two metrics have traded on top of each other, and diverge any time there is a liquidity crunch. Curiously, the current dispersion level is far wider than any seen during all of 2009, and only got to its current record level in the aftermath of the Greek rescue. As such, the liquidity imbalance of 10% could provide an unleveraged arbitrage to investors who wish to play a spread convergence.
The chart below demonstrates the absolute spread between the two metrics:
The next chart indicates the relative underperformance of EUR Libor compares to Euribor.
Also, courtesy of the far bigger panel of Euribor participants, we can get a far better look at which banks could be undergoing a solvency crisis. Not surprisingly, the two most stressed banks are Spain's BBVA and the recently notorious CECA (Confederacion Española de Cajas de Ahorros), both of which have reported a Euribor well over 10% above the average. Although curiously, on Friday, May 28, the BBVA spread over average collapsed from an average spread of about 16% to just 3.2%. Whether this is a misprint is unclear - we will update the data once we obtain today's closing Euribor data. The other riskiest banks that complete the Top 5 are Allied Irish, French BNP Paribas and Belgian Dexia (with Calyon, DZ Bank, LBBW, CIC and Danske Bank rounding out the top 10).This can be seen graphically on the chart below where the ten widest banks compared to the Euribor average are shown with their spread during each day of May.
The same analysis on the other side, or capturing the ten "cheapest" banks to the Euribor average, presents the most liquid banks in Europe - these are primarily the soverign bailout recipients: UBS, HSBC, Barclays, RBS, JPM, BCEE, Rabobank, Deutsche, Citi and CGD.
The take home message here is that readers who have deposits with the first set of banks may consider shifting their capital elsewhere, preferentially in the ten "safest" banks. Another arbitrage would be to take advantage of the Libor-Euribor disconnect directly, and synthetically play a convergence trade by shorting EUR Libor and going long Euribor. If this trade is a little complicated (although with a 10% unleveraged spread the probability of a Boaz Weinsten-type basis trade blow up is marginal at best). Probably the best trade is to load up a basket of CDS in the ten highest Euribor paying banks (BBVA, CECA, Allied Irish, BNP and Dexia), either naked or hedged by selling protection in the top 5 banks. Because liquidity always walks at the end of the day. And absent the Fed as a last-case liquidity backstop to Europe, the Euribor panel of 42 banks will not remain at that number for long.