Banks Responsible For Sudden European Liquidity Crunch Identified
There goes another "fat finger" red herring. On Thursday and Friday, when we noted that borrowing under the ECB's Marginal Lending Facility has spiked from roughly €1 billion to €16 billion for two days in a row, we mocked the MSM explanation that this was merely the result of a fat finger, or at worst a faulty recalendarization of a term-MRO borrowing activity for an overnight one (at the exponentially higher rate of 1.75%). As expected, and as we predicted, this was indeed a case of bank gone wrong. Or two. The FT reports that "Anglo Irish Bank and the Irish Nationwide Building Society, Ireland’s two most troubled lenders, were behind a spike in overnight borrowings this week from the European Central Bank, according to people familiar with the transactions." And while we now know who the guilty parties are, the explanation once again leave much to be desired. It is no surprise that all European banks are exclusively reliant on the ECB for funding, which as previously indicated confirms that the Euribor market is a relic of the past since nobody approaches other banks for capital - everyone goes straight to uncle Jean Claude... And in doing so pledges any and all collateral, even if it means running an outright ponzi scheme. "Both
banks have become heavily reliant on the ECB’s liquidity funding over
the past 2 years, as they have been unable to roll over maturing bond
debt and have seen an outflow of deposits." Yet instead of acknowledging that this action is merely a liquidity crunch, the FT's explanation is that the surge in borrowing has to do with the ability to unwind collateral on a moment's notice as a function of the banks' restructuring, instead of having it locked up for a week under the MRO. We are not sure if this "explanation" is just as, or more, laughable than the fat finger one.
From the FT:
A senior figure familiar with the transaction said it was “to facilitate” the sale of deposits by Anglo Irish and Irish Nationwide under the restructuring plan. Under the ECB’s normal refinancing operations, the collateral is locked up for a week. Tapping the ECB’s overnight or “marginal lending” facility, although more expensive “gives the banks the freedom to have the assets at their disposal immediately if there is a quick sale,” he said.
Earlier this month, Anglo Irish said its borrowings from the ECB and from the Irish Central Bank – under the emergency liquidity assistance programme which applies slightly less onerous collateral eligibility rules – doubled to €45bn in 2010.
However the assets used as collateral by both institutions to be able to borrow from the ECB are now being hived off as part of the lenders’ restructuring.
The main collateral pledged with the ECB to borrow is the government backed bonds issued as consideration for the impaired property loans that are being bought by the National Asset Management Agency, the government’s bad bank loan agency.
What is amusing is that while the logic works in theory, in practice it doesn't. Yesterday we said that "As European collateral has no quality thresholds, and as the ECB will
accept anything, it makes no sense for any bank to pay incremental
interest just to transfer borrowing to an overnight facility with a
punitive rate - simple as that." The proposed explanation by the FT's "sources" is the only logical one under these parameters. Yet the trade off of a surge in interest in exchange for collateral flexibility makes little to no sense. First of all, NAMA is not supposed to start auctioning off deposits and other assets of the two failed banks for at least several more weeks, which does not justify paying the much higher overnight rate just to have the facility of not having a holding term locked in. Secondly, it is very naive to assume that the ECB would not release collateral even under a term facility at the moment's notice if the underlying bank requested it. After all, the ECB is more concerned with bank contagion (i.e., the truth coming out) than anything.
Yet the good news is that now this deterioration is fully priced in and the levitation ramp may continue. And not just through Tuesday as Citi's Jurgen Michels expected. It may well go on for weeks until the supposed liquidation of collateral is consummated. What will be enjoyable to watch is just how much more MLF lending surges by in the same period, and how many other banks claim the same straw man excuse.
Traders say the two lenders are expected to continue to rely on overnight borrowing for a couple of weeks as final plans are made to sell the Nama bonds as part of the wind down plan.
Our prediction is to keep an eye out on the parallel shift between various term ECB tender operations. If indeed there is a scramble in broader Europe for freeing up collateral on a moment's notice, which reading between the lines of the FT's article implies, more and more banks will shift their holdings from LTRO facilities (28, 91 and 98 day) , to 7 Day MROs and finally to the overnight 1.75% Marginal Lending Facility. All of a sudden the European treasury curve for many continental institutions may get a whole lot flatter...
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