Encumbrance 101, Or Why Europe Is Running Out Of Assets

Tyler Durden's picture

Since the much-heralded 3Y LTRO program was envisioned and enacted, we have been clear in our perspective that while this appears to have signaled a removal of downside (contagion-driven) tail-risk for banks (and implicitly to sovereigns), the market's perceptions are once again short-termist. Missing the unintended-consequence for the sugar high is something that we have seen again and again for the past few years but we worry that this time, given the sheer size of the program, that the ECB has got a little over its skis. By demanding collateral for their bottomless pit of low-interest loans, the ECB has not only reduced banks' necessary deleveraging needs (and/or capital raising) but has increased risk for all bond-holders (and implicitly equity holders, who are the lowest of the low in the capital structure remember) as the assets underlying the value of bank balance sheets are now increasingly encumbered to the ECB. Post LTRO, Barclays notes that several banking-systems (PIIGS) now have encumbered over 15% of their balance sheets but LTRO merely extends a broader trend among European banks (pledging collateral in return for funding) and on average (even excluding LTRO) 21% of European bank assets are now encumbered, and therefore unavailable for unsecured bond holders, ranging from over 50% at Danske (more a business model choice with covered bonds) to around 1% for Standard Chartered. As the liquidity-fueled euphoria starts to be unwound, perhaps this list of likely stigmatized banks is the place to look for higher beta exposure to the downside (especially as we see EC B margin calls start to pick up).


Via 'Encumbrance at European Banks' per Lehman's successor entity

Who cares about funding anymore? While €1trn of 3-year LTROs takes funding risk off the table near term and helps buy time in managing the European sovereign debt crisis, we think there remain several reasons to stay concerned about bank funding longer term.


A rising trend of encumbrance: Even before the LTROs, a growing feature in Europe was rising balance sheet ‘encumbrance’ – the pledging of collateral to one group of creditors at the expense of another. The most obvious example of this is the rise in covered bonds, accounting for 40% of debt issuance in 2011. The LTRO exacerbates this trend. Post LTRO, several banking systems now have encumbered over 15% of their balance sheets.



Declining bondholder recovery rates keep funding costs high: Bondholders face increasing subordination from this balance sheet encumbrance, reinforced by depositor preference laws (in some countries) and imminent legislation on bail-in bonds. Combining these factors suggests that unsecured funding cost for banks will remain high – potentially too high for some business models to make economic sense.


What can the banks do?: If funding costs can’t come down to economic levels, banks will either have to look for other sources of funding, or shrink. Alternative funding sources could include further covered bond issuance (encumbering balance sheets further) or aggressive growth of deposit franchises (thereby shrinking lending margins).


What can policymakers do?: One offset to lower recovery rates is to reduce the probability of default. It is unclear whether Basel 3 compliance does enough to re-assure funding markets. If not, we may need further ECB measures to support banks now that the precedent of the 3-year LTRO has been set. This increases the perception of the ‘nationalisation’ of funding structures.

Encumbered assets % of Total Assets (excluding derivatives) EURmm...


In some cases, such as the Scandi banks and their covered (mortgage) bond, the levels of encumbrance are not always a sign of a broken business model - but we have highlighted several names near the top of the encumbrance tables that also rely heavily on repo (a topic have been thought leaders on for some time) as potentially problematic.

In a nutshell, the ECB (or broad collateralized lending liquidity facilities) has taken more and more of the balance sheet of Europe's banking system out of the reach of the private debt markets (and real money) - leaving fewer and fewer assets at the bottom of the pyramid and leaving less and less quality collateral available (otherwise why would be seeing ECB margin calls on such a large scale so quickly).  

Whether it be their direct actions with Greece (specifically subordinating the world) or their indirect actions with LTRO collateral needs, the systemic risk of Europe's banking/sovereign credit system is far higher now than it was before (and credit markets have already begun to adjust to this new reality - senior spread decompression, recent sovereign underperformance, and LTRO-Stigma - even if equities remain dumbstruck with the implicit print-fest - though very recently European financial equities have joined the credit drop more closely).

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BW's picture

The ongoing financial war is accelerating with arrests and assassinations being seen on both sides. George Bush Senior and Bill Gates were arrested last week for sabotaging the new financial system after being fingered by Timothy Geithner, pentagon sources say


Orly's picture

I only wish it were real...

knukles's picture

Burma Shave signs around Europe


Re encumber

Don't be late

Re re re


Debt Away

Manthong's picture


Wasn’t that a Burt Reynolds movie with a little inbred Greek up on a swing playing “Dueling Bouzoukis?”

                    I know there was some Greek in there somewhere.

Renfield's picture

Yeah, the most famous line in the film. "Squeal like a Greek, boy!"

Manthong's picture

Ha ha.. yeah, it was "Squeal like a PIIG (the S must have been implied).

PersonalResponsibility's picture

Get him to the Greek...



"The plan worked, now that's a mind fuck."  <-- I need to post this more often.

Ahmeexnal's picture

there aint certainly no shortage of asses in the EU: a german pontiff, an italian master banker, a belgian non-emperor, a pseudo-french buffoon....and of course the millions of dumbasses who have happily accepted their slavery.

no offence to the quadruped long eared (and world famously well-endowed) sturdy beasts.

Buck Johnson's picture

The rehypothication is just printed money, Inflation or hyperinflation is on the way.

WmMcK's picture

He asked
His kitten
To pet and purr
She eyed his puss
And screamed
"What fur!"

bugs_'s picture

i just don't understand why there are any pesky laws, rules, procedures etc still stopping the world bailout - hasn't all this stuff been completely swept aside yet?

Renfield's picture

For "Confidence".

In a currency collapse, the last thing to go is confidence. Unless TPTB go thru the motions of having standards, following procedures, and enforcing rules, global confidence in their fiat would evaporate. Then it would be game over for them. All they have is each other and they're trying to show a united, confident front to postpone the moment that it all falls away. They know that when it finally topples, it will be fast and it will be bad.

But for now, they have the MSM and large pension & mutual fund managers still listening. There is still a common language with common assumptions, altho they are eroding fast. The big banks won't lend to each other but they still have confidence in their respective central banks.

Hence, the charade continues. For those of us who have been awake for years, it's a slow, slow process.

I'm torn between gratitude for all this time I have to shore up supplies and prepare to endure a long, cold, hard Depression - and watching these parasites play their game week by week, month by month, year by year, until I want it all to fall apart now before it drives me mad waiting.

Caviar Emptor's picture

MadMax2: Road Warrior. Hold on to the things that count. 

A Nanny Moose's picture

Could you keep it down? March Madness is about to start.

stopcpdotcom's picture

My brain just exploded. Excuse me while I pick up the pieces.

VelvetHog's picture

Hard assests for fiat!  Excellent!!

Greenhead's picture

It was my understanding that the ECB took the worst collateral the banks had and gave them good Euros on the face value.  If you are worried about encumbering very weak assets by monetizing them and letting the banks make money and build capital, then I am very confused.  I thought that was the ultimate purpose of a Central Bank, to provide a backstop and a way to build capital for its member banks.  If a by-product of the operation is funding bankrupt countries, well, so much the better. (sarc).

Renfield's picture

What ZH needs is more of your optimistic, win-win perspective!!!!111one

(heh - can't help it, I'm at the stage where I gotta laugh so as not to cry)

Ghordius's picture

+1 the ZH narrative is that CBs never ever do anything right...

Vince Clortho's picture

CBs always do what is right for the Kleptocrat Oligarchy.  They get that one right every time.

withnmeans's picture

Does Greece know something we don't? Or has TPTB started growing a society of "Mushrooms". Somebody is in the dark, after reading this article looks like great times are in store for the once impoverished country.



FinsterMonster's picture

Some thoughts about the article:

Pension funds did take part in the PSI. http://www.zerohedge.com/news/least-4-greek-pension-funds-including-poli...

The 20% value of the new greek bonds in the gray market do point to a new restructuring in the not too distant future.

What I'm wondering is how the article writer get this to heighten the willingness to invest in Greece by saying that a Euro exit is off the table (or risk virtually zero) after PSI. No exit from a sinking ship is for me not a positive thing. And who would want to invest in a country that most certainly will declare default again?

My two cents.

Renfield's picture

You said: "No exit from a sinking ship is for me not a positive thing".

For me neither. And yet, the story is that the euro will never, ever fail, from what I can gather largely because Germany is considered unsinkable. This to me seems ridiculous, but everyone points at Germany as the heart & soul of the euro, and the answer to everything. I would not want to be tied to Germany, with their sinking export economy and their stupid willingness to take on huge levels of debt run up by other countries.

But I can't help wondering if there is some implicit understanding of a "Plan B", a "northern euro" that includes or partners with Russia, maybe even China, ditching the deadbeat south in good time and emerging as a new economic axis fully formed behind closed doors. So maybe in this way the euro won't fail, but is getting ready to be unveiled. Maybe this is where the tremendous faith in Germany and the euro comes from.

fredquimby's picture

But that's the whole point of the EURO. No exit possible & not dependent on one state for success!!

You see, there are two fundamental differences between the euro and the dollar that most Westerners simply can't grasp, no matter how many times you try to explain their significance. Wim Duisenberg, the first ECB president, stated them pretty clearly in this 2002 speech:

"The euro, probably more than any other currency, represents the mutual confidence at the heart of our community. It is the first currency that has not only severed its link to gold, but also its link to the nation-state. It is not backed by the durability of the metal or by the authority of the state. Indeed, what Sir Thomas More said of gold five hundred years ago – that it was made for men and that it had its value by them – applies very well to the euro."

There's a lot in that one paragraph, but the two fundamental differences with the dollar are the severed links to gold and the nation-state.

H/T   http://fofoa.blogspot.com/2011/07/euro-gold.html



Renfield's picture

OK...this is the whole idea of the euro as a medium of exchange, right? But I'm afraid that this is like trying to speak an entirely different language for me. (I have read several FOFOA articles and thought a lot about this. But I still find things very problematic.)

I completely understand FOFOA's emphasis on gold as a store of value. AND that the medium of exchange should be separate from it.

BUT, why should that medium of exchange be the euro as opposed to another fiat, for example, the USD?

The euro is encumbered with unpayable debt, having pledged brutal levels of future taxation on its people, levels that are not only inhumane but quite unrealistic. It is no different, that I can see, from the USD - since I do understand that it is, in fact, NOT connected with gold except as an asset to be valued at market and treated as collateral against fiat debt. But when that collateral is gone, it's gone - and you are just left with the euro, an empty medium of exchange. Whereas the USD relies on the petrodollar and the "reserve currency" system, neither of which will last any longer than Europe's gold will.

So, you have the euro, vs. the USD:

euro & USD - encumbered with exponentially increasing, unrealistic levels of debt
euro & USD - pledge unrealistic & brutal levels of taxation as surety for such debt
euro: marks its gold to market, and allows such gold to stand as collateral against such debt (e.g., Greece)
USD: petrodollar (in a slow process of dismantling by developing nations, even if we ignore Peak Oil); "reserve currency" status, also in a slow dismantling

You say that not being linked to a nation-state is a strength. I do not understand this either: how is this growing debt to be repaid without the power to tax?

I cannot understand how the euro can be taken any more seriously than the USD in terms of DEBT and, viewed against such debt, why should we choose it as a medium of exchange? Should a medium of exchange not be free of debt? (Debt being a measure of wealth - or rather, a reductive measure of wealth.) I guess I'm trying to say that I can't see how you can treat a debt-based currency as a medium of exchange. The euro is a debt-based currency, just as the USD is, is it not?

In short, the problem with the euro is debt. Interest-bearing debt rises exponentially. The price of gold does not, even if it floats and is measured daily.

Sorry about the huge flow of small words. The language of money is not my mother tongue. :-)

sessinpo's picture


"The euro is encumbered with unpayable debt, having pledged brutal levels of future taxation on its people, levels that are not only inhumane but quite unrealistic. It is no different, that I can see, from the USD - since I do understand that it is, in fact, NOT connected with gold except as an asset to be valued at market and treated as collateral against fiat debt. But when that collateral is gone, it's gone - and you are just left with the euro, an empty medium of exchange. Whereas the USD relies on the petrodollar and the "reserve currency" system, neither of which will last any longer than Europe's gold will."


My comment: I think you understand things better then you think.

It's all about control regardless of which medium of exchange is used.



"In short, the problem with the euro is debt. Interest-bearing debt rises exponentially.

My comment: That is the problem of all fiat currencies and its fallacy and what ultimately destroys it.

Politicians and global bankers are gods in their own mind. It's hard to imagine a positive result of that.

ebworthen's picture

When is the ship going to sink?

I'm getting tired waiting for the Titanic to go down and for the "Unsinkable" to be sunk.

sitenine's picture

Rubbish!  There are plenty more soccer players to pledge as collateral!


I heard that quality headline rumors are accepted as well.

knukles's picture

Betcha Bob Pissonme and Steve Liteman start on early a.m. about how the deal was taken care of, alls fixed, well, healed, no more tears, full empolyment for everyone, an underage hooker in every pot (er, something like that for the Goldman boys) buy the Piss out of European Financial Stocks, go Long all the Greek Sovreign Debt you can cram up your ass in one sitting, it's OK ma they're only bleeding, of course the waters potable, don't feed the chickens unlike people they'll get reliant upon their masters, free drugs sex and rock and roll forever, the sun still rises and my penis is bigger then your penis when I use the New Improved Penis Extension Pump, guaranteed to make it's head look like a mongoloid cross between Lord Balnkfield and Von Rompie.
It's all OK
The blind can see, the lame run, the constipated shit....
We're home free in a foreclosed house with no fucking where to go.

Beats working. 

Mr Lennon Hendrix's picture

Pissface was let into the SPDR GLD vault.

He must have very soft hands.

Caviar Emptor's picture

And every time they've pronounced the crisis dead, it came back to bite them on the ass cheek. And that's a key reason their viewership has dropped so badly since the crisis: Credibility. The 1s and 0s flowing from behind the faces were revealed for all to see: they're just a 24-hour info-mercial for the Wall Street Matrix. 

nmewn's picture

Can I interest anyone in some paper tickets for your simple laws and ethics?

Alexandros's picture


Global Debt Crisis

The greatest private fraud of human history.

Who are the great fraudsters who are becoming the murderers of the human kind? How does the economy "illness" threaten Democracy and the freedom of people?



World War III - The First Private War in History

Those who won all battles shall lose the war.

Bilderberg Group and the crimes against humanity.





falun bong's picture

What if everybody prints/debases at the same time (as they are)...wouldn't that be like a slow global Jubilee?

Just wonderin'

tallen's picture

When will this "It can only go higher" market finally implode. Soaring unemployment, collateral quality dropping to new all time lows. (Football players, surely it can't get worse than that?) Not to mention CDS getting triggered and the ridiculous leverage in the system. Iran and the possibility of $200 oil, destroying what little else is left of the US consumer debt driven economy.


Maybe I should just go live in magically fairy land and believe Apple will continue its earnings growth and consumers will keep up demand for their iProducts no matter how expensive/little features are added.


Caviar Emptor's picture

Don't forget the game of musical chairs is in play and 10 million chairs were just removed. Now the music is playing for those who remain. After the next round though, only those connected to the Ponzi will still be in the game. And life is good. 

Wakanda's picture

Can't they figure out a way to turn debt into assets?

Oh wait...

gookempucky's picture

What should also start to worry the Germans is the fact a 37x levered hedge-fund central bank with EUR3 trillion balance sheet that has extended credit in a 'risk-managed' approach on what appears to be an ever dwindling supply of performing collateral is starting to see dramatic 'gaps' in its asset-liability exposure.

It is the ___?____ X levered that is missing in the equation for global ponzinomics. And at 21% aggregate this number is eenormus. Hold on to your Au and Ag.

slewie the pi-rat's picture

this was worth the price of admission:  This increases the perception of the ‘nationalisation’ of funding structures.   thanks, tyler!

personally, i don't see new baselIV accounting rules, baselIII is only being implemented now, after it's first week, and should indicate the quick and the dead, as these banksters know only too well

now, the sovereign debt isn't "worth" as much as collateral to the [sub-ECB] borrowers;  m2m (mark-to-market) activity and zome of the more unzuztainable zombiez may be liquidated, "conzolidated", or used as zuppozitoriez for taxpaying citizenry

"risk" is something i leave for others to masticate in this illusion-ridden landscape of top-hatted promises and "cash" flows from digital printers and friends in very high places

steady, mates; hold her right there, now... 

here's the major paper-hanging from last week pasted from dougNoland'sPrudentBear:

It was the strongest week of debt issuance ($50bn plus) since last May.  Investment grade issuers included Phillips 66 $5.8bn, Hewlett-Packard $2.0bn, DirecTV $5.0bn, Xerox $1.1bn, URS $1.0bn, Newmont Mining $2.5bn, PNC $1.0bn, Wynn Las Vegas $900 million, Genworth $750 million, Marriot International $600 million, Silgan $500 million, Hexion $450 million, Progress Energy $450 million, Southern Cal Edison $400 million, Con Ed New York $400 million, Masco $400 million, Omega Healthcare Investors $400 million, Domtar $300 million, Mississippi Power $550 million, Marsh & McLennan $250 million, and Western Group $185 million.

Junk bond funds saw inflows increase to $957 million (from Lipper).  A notably long list of junk issuers included Coca-Cola $2.75bn, Centurylink $2.05bn, Simon Properties $1.75bn, CHS/Community Health Systems $1.0bn, Kinder Morgan Energy Partners $1.0bn, Continental Airlines $900 million, Continental Resources $800 million, American Tower $700 million, Fidelity National $700 million, Concho Resources $600 million, Berry Petroleum $600 million, EV Energy Partners $500 million, Bill Barrett Corp $400 million, Covana $400 million, DCP Midstream $350 million, Verso Paper $345 million, Ofice Depot $250 million, and Key Energy Services $200 million.

Convertible issuance included Priceline.com $875 million and Helix Energy Solutions $200 million.   

International dollar bond issuers included Toronto Dominion Bank $3.0bn, Mexico $2.0bn, Mitsui Sumitomo Insurance $1.3bn, Oversea-Chinese Banking $1.0bn, Commonwealth Bank Australia $2.5bn, Philips Electronics $1.5bn, BE Aerospace $500 million, Hyundai $500 million, Berau Coal Energy $500 million, Orix $500 million, Bombardier $500 million, Masonite International $375 million and Salta $185 million. (endPaste)

this "cash" is longer on the sidelines, BiCheZ!  and, it just might be used in "consolidations" of various kinds, too! 

but what about this?  if the net junk bond inflow was less than $1 Bil ($957 Mil) da boyz were rolling a ton of stuff over b/c there's 14-15 $ Bil right there on the list...  if we accept these numbers, that seems to be what they say...

Mr Lennon Hendrix's picture

I still can't believe these fuckers are holding this shitpile together.

AU5K's picture

All of this for a cradle to grave, socialized, care-free Eurotopia. 


This is going to be one expensive nanny.....

crawl's picture

Is there an easy way to short a basket of European bank stocks, like a double or triple short ETF?

SillySalesmanQuestion's picture

Do so at your own peril...no shorting allowed.

crawl's picture

That's my understanding.

Plus shorting can be a losing proposition, especially with manical central banks on the loose.

Non Passaran's picture

Not these days, but long-term you're right.

carbonmutant's picture

The unintended consequences of sugar dependence...

booboo's picture

truth  decay.