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LTRO: A User's Manual

MacroAndCheese's picture





 
LTRO is the acronym given to the European bank lending program that has been compared to the "quantitative easing" initiatives of the U.S., known as QE I and QE II, and to similar measures undertaken by Japan and the United Kingdom. This European program was initiated by Mario Draghi, the newly appointed President of the European Central Bank, or ECB. Two LTRO tranches have been announced so far, one that took place on December 21 of last year, and a second to occur on February 29. The ECB refers to LTRO as a "non-standard measure," designed to alleviate severe credit conditions among the countries of the Eurozone.
 

LTRO.JPG

 

Although LTRO is a European initiative, the reaction of US stocks has been nearly identical to the move that followed the signaling of QE II in August, 2010. QE II was not implemented until November of that year, but market participants date the initial impact of QE II to a speech delivered by Fed Chairman Ben Bernanke, with markets rising in anticipation of the program.  The chart above illustrates the reaction of the S&P 500 stock index to both programs.

 

Similarly, European stocks surged in reaction to QE II, with the DAX, for example, rising more than 15% during the three months following the Jackson Hole speech, and about 18% since the December 21 announcement of LTRO. The impact of these two initiatives has been felt on both sides of the Atlantic.

This summary provides an overview of the program, including what it is, how it works, who is affected, and what we may expect in terms of the second LTRO.

What is LTRO?

LTRO is the acronym for "Long Term Refinancing Operation," the term that describes a major financing method used by the ECB to provide liquidity to its member banks. Contrary to popular belief, LTRO has been in existence since the inception of the Euro in 1999, though the tenor of the program was generally restricted to refinancing of three months. Beginning in 2009, the ECB began conducting 12-month refinancing operations, also seen as a "non-standard measure."

How does the current LTRO differ from the original program?

Unlike traditional ECB LTRO, the LTRO instituted by President Draghi lasts for three years rather than several months, with the banks' option of terminating the financing after one year. In addition, and very importantly, the standards for collateral eligibility have been relaxed considerably, making it much easier for banks to obtain funding.

What is the purpose of LTRO?

LTRO eases credit conditions in the Eurozone in two ways:

(1) allows banks to borrow unlimited funds for three years, as long as the banks can provide eligible collateral; and

(2) assists banks in managing their "gap risk," that is, facilitates the ability of banks to match the tenor of their assets and liabilities. Prior to LTRO many banks were only able to secure overnight funding.

The ultimate goal of LTRO as stated by President Draghi is to foster loans to the Eurozone private sector in order to support employment.

How does LTRO work?

LTRO is straightforward: All member banks interested in participating may do so. Banks may participate as long as they provide eligible collateral as a pledge against the LTRO loan. Eligibility requirements are not set in stone, though generally securities must be A-rated. The process is largely electronic and automated, including a comprehensive list of eligible collateral that can be readily accessed in order to confirm eligibility.

Collateral can be pledged directly to the ECB, or alternatively, to the central bank of the country of the borrowing member bank, as a "temporary solution."  In other words, French banks are able to access LTRO funding by pledging securities to the Bank of France rather than directly to the ECB. President Draghi has stated that the "responsibility entailed in the acceptance of such credit claims will be borne by the national central bank authorizing their use." In so doing, the ECB reduces its risk and delegates credit authorization to the central bank of the borrower. This measure significantly widens the scope of eligible securities.

What are the collateral eligibility requirements for LTRO?

The ECB provides a detailed eligibility list by country, though this list is not comprehensive and has evolved over time. Collateral must have a second-best credit rating of single A, whereas previously a AAA rating from two agencies was required. A wide range of instruments is permissible, including bonds, loans, asset-backed securities, etc. At the press conference following the ECB's monthly meeting held on February 9, President Draghi announced that the ECB will further expand the list of eligible collateral.

What is the size of LTRO?

The LTRO program is unlimited in size, said to be "full allotment." The first tranche of LTRO was for EUR 489 billion. Of this amount, approximately EUR 296 billion consisted of the rolling over of previous short-term loans with the ECB. It is not yet known how large the second tranche to be announced on February 29 will be. Estimates have ranged from EUR 300 billion to over EUR 1 trillion.

How many banks took part in the first tranche of LTRO?

523 banks participated, alleviating concerns that banks that took part would be stigmatized as a troubled institution. However, there is some evidence that certain banks avoided LTRO for this reason.

What are the terms of LTRO loans?

As mentioned, there is no limit to the size of loans available, provided that member banks post eligible collateral. The tenor of LTRO loans is three years, although banks may terminate after one year. The interest rate charged to borrowing banks is based upon the average of the overnight rate during the loan period, currently 1%. Substitution of collateral is permissible as long as the substituted collateral also meets eligibility requirements. There is a "haircut" according to the type and quality of collateral; that is, the loan is somewhat smaller than the market value of the collateral. This haircut acts as a credit cushion to the ECB and central banks.

How does LTRO differ from the QE of the United States?

The Federal Reserve's QE program is conducted in the open market, rather than directly with member banks. Under QE, the Fed purchases bonds of higher quality (only AAA-rated mortgage bonds or Treasurys are acceptable), with no determined termination date. In addition to the goal of injecting liquidity (cash) into the system, the Fed has stated that it looks to lower interest rates through its purchases, especially those associated with the mortgage market, in order to stabilize the residential real estate market.

The primary purpose of LTRO is to stabilize the Eurozone banking sector by providing member banks with liquidity, particularly over the medium term. Additionally, since LTRO was initiated, the cost of borrowing of most of the countries of the Eurozone has decreased significantly. Although the ECB has not openly suggested that banks buy Eurozone sovereign debt to be used as collateral, French President Nicolas Sarkozy has encouraged the practice.  Such purchases may have contributed to the decrease in sovereign borrowing costs.

What are some criticisms of LTRO?

Critics charge that in conducting LTRO, the ECB and other Eurozone central banks are overly extending their balance sheets, while at the same time increasing their credit risk by accepting collateral of a quality lower than has been customary. Some are concerned that instead of reducing their balance sheet and credit exposure, Eurozone banks are taking on more risk by adding to their holdings of sovereign bonds of the "peripheral" (weaker) countries. Still others are concerned that LTRO will result in a decrease in the M3 money supply, since secured ECB lending is not included in that measure. A further concern is that banks will not use the funds to make loans to the private sector, and point to the recent rapid rise in overnight deposits at the ECB as evidence of this phenomenon.

 
 

 

 

 


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Tue, 02/14/2012 - 02:03 | Link to Comment aerial view
aerial view's picture

LTRO or "Let's Thank (the) Real Oligarchs" by bailing them out again and again with no interest free money or "heads they win, tails we lose"!

Mon, 02/13/2012 - 23:10 | Link to Comment ThisIsBob
ThisIsBob's picture

What involvement does the US Fed have in this? 

Mon, 02/13/2012 - 21:29 | Link to Comment Yes_Questions
Yes_Questions's picture

 

 

Long Time Rip Off

Mon, 02/13/2012 - 20:07 | Link to Comment YesWeKahn
YesWeKahn's picture

LTRO = ECB buys everything banks have with fake money (the money it doesn't own). If the underlying asset lose value, ECB has no accoutability of default itself, the money is simply printed and disappeared. This is a total fraud!

Mon, 02/13/2012 - 19:54 | Link to Comment swani
swani's picture

LTRO=Moral Hazard

LTRO=Ponzi Fuel

LTRO=Can Kicking

Mon, 02/13/2012 - 18:56 | Link to Comment HD
HD's picture

Central banks print fake money to pay real government debt - which hurts growth and damages the very markets they are trying to protect.

Mon, 02/13/2012 - 18:44 | Link to Comment Bunga Bunga
Bunga Bunga's picture

LTRO = Lucy's Trips' Rainbow Outerlimits

Mon, 02/13/2012 - 18:36 | Link to Comment Ned Zeppelin
Ned Zeppelin's picture

 

 

1. No, really - the check is in the mail, I swear.

2.  What? Whitney Houston didn't have a drug problem!

3. The ultimate goal of LTRO as stated by President Draghi is to foster loans to the Eurozone private sector in order to support employment.

Mon, 02/13/2012 - 23:30 | Link to Comment MacroAndCheese
MacroAndCheese's picture

Yep, nearing "dual mandate."

Mon, 02/13/2012 - 17:20 | Link to Comment ebworthen
ebworthen's picture

LTRO = Long Tail Robomarket Orthogonalization.

"What's our vector Victor?"

http://www.youtube.com/watch?v=fVq4_HhBK8Y

A 1% rate on nearly limitless loans?  They clearly had the fish.

Mon, 02/13/2012 - 22:22 | Link to Comment WmMcK
WmMcK's picture

Just another eigenvert in the matrix.

Mon, 02/13/2012 - 17:05 | Link to Comment Mr Lennon Hendrix
Mr Lennon Hendrix's picture

What is the collateral from the ECB to make the loans?  Freshly printed euros that will be paid back from taxes collected on Greeks, Portugese, French, and Germans?  I think so.

Just to bail out a group of insolvent banks.  Insolvent banks that have no owns best interest except themselves.  'Tis a shame.

Mon, 02/13/2012 - 16:56 | Link to Comment Uchtdorf
Uchtdorf's picture

http://www.youtube.com/watch?v=P3j2oTziRg0

Mamas don't let your babies grow up to be bankers.

Mon, 02/13/2012 - 16:20 | Link to Comment Nobody For President
Nobody For President's picture

I'll call it a reasonable and straight-forward FAQ on LTRO that I can point a few interested friends to. Also reasonable in length...Thanks!

Mon, 02/13/2012 - 15:50 | Link to Comment MacroAndCheese
MacroAndCheese's picture

Wow sorry for the technical difficulties, hard on the brain.

Mon, 02/13/2012 - 20:03 | Link to Comment ninja247
ninja247's picture

An excellent, cogent article.

Please, macro,keep up the good work.

Mon, 02/13/2012 - 21:02 | Link to Comment MacroAndCheese
MacroAndCheese's picture

Thank you Ninja, much appreciated.

Mon, 02/13/2012 - 21:41 | Link to Comment Atomizer
Atomizer's picture

Nice job.

Mon, 02/13/2012 - 15:47 | Link to Comment Mongo
Mongo's picture

Well

...

The ultimate goal of LTRO as stated by President Draghi is to foster loans to the Eurozone private sector in order to support employment.

Well that is a fail with youths eating their body parts soon...

Mon, 02/13/2012 - 15:45 | Link to Comment Joebloinvestor
Joebloinvestor's picture

LTRO = Euro speak for kicking the can a lot further down the road.

Mon, 02/13/2012 - 18:52 | Link to Comment Ghordius
Ghordius's picture

3 years? I thought this is funding, not "liquidity".
And still, it's quite clever and possibly much better suited than a "blunt" QE.
It caught me by surprise and I expect interesting side effects from it...

Mon, 02/13/2012 - 16:16 | Link to Comment falak pema
falak pema's picture

Ltro is the european component of the world Oligarchy cabal to print to infinty, thus to save their collective skins as owners of assets based on total debt financing. And it won't end until they own the whole world economy, labour and RM. Then the very notion of debt won't count as those who are creditors are part of global construct. It is totally circular, where the owners live off interest from debt, ensuring the world carries the debt on its shoulders, the 99%; while the 1% carries the profits, the interest being paid to surrogate collective institutions that oil the wheels of the debt machine and ensures all surplus goes to 1% and all incident debt goes to the 99%. Perfect perpetual capitalist machine. 

The flaw is that since time immemorial Oligarchs have this habit of falling out...human nature and hubris being what it is. 

Lets pray together it breaks fast this hubristic bubble. If we stay divided we help the global machine. Its ironic how the world is now moving from twentieth century logic backwards to nineteenth and then assuredly to eighteenth and so on. Regression guaranteed!

Mon, 02/13/2012 - 18:55 | Link to Comment Ghordius
Ghordius's picture

Wake me up in the century best suited to my skills...

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