Here Is The Math: Carry Trade Profits From The LTRO Are Woefully Insufficient To Make Any Impact

Tyler Durden's picture

Following yesterday's €489 billion LTRO there are few things we know with certainty, primary among them is that the net proceeds from the 3 year refi operation are really €210 billion, due to the rolling of various other duration facilities which are already in use into the LTRO as discussed yesterday. What we do not know, is whether the net proceeds of €210 billion have been used by banks to purchase sovereign debt or as Peter Tchir suggested, are actually used in a reflexive ponzi whereby banks use the explicit ECB guarantee to buy their own debt. Perhaps the best evidence that the LTRO was an epic failure when it comes to subsidizing the peripheral bond market is the fact that hours after its completion the ECB was forced to jump into the secondary market and buy up billions in Italian and Spanish bonds: an action that was supposed to be conducted by the banks themselves. But let's assume that the entire €210 billion form the first LTRO (and there certainly will be more) is used to fund carry trades: what then? Well, luckily UBS has performed a mathematical analysis which looks at how much paper profit banks can extract from said trade and juxtaposes it with the most recent €115 billion capital shortfall calculated by the EBA in its most recent stress test (not to be confused with the second to last stress test which saw Dexia pass with the highest marks possible). The result: woefully insufficient . In other words, anyone who believes that the LTRO will be used by banks as a source of carry "profits" is massively deluded. If anything banks will find creative loophole to prop up their balance sheets and issue more of their own debt instead of chasing pennies in front of the bond vigilante rollercoaster by loading up on more sovereigns. Because the last thing Italian banks can afford is another late Novemeber blow out in yields which brought the system to within hours of imminent collapse.

Below we present the hypothetical analysis from UBS Atsushi Ito, which was conducted before the final allocation was known. Keep in mind that UBS assumes an amount of €320 billion is used for full carry allottment. Instead we know that the most currently available is €210 billion or 66%. In other words, take all the numbers, notably "profits", from the analysis, and haircut them by a third.

Hopes have heightened that the 3yr LTRO might inspire a market rebound. As such, we shall now look at the LTRO in terms of the impact it might have on the bond market, as well as on other market players. Here, our analysis concludes that it is highly likely that any term profit and loss improvement seen by banks will fall short of providing enough punch to resolve the issue of bank undercapitalization by the end of June 2012.


Operations: Banks buy sovereign debt on the open market, and then offer them to the ECB as collateral for 3yr loans. To arrive at banks' net profit under this scenario, we subtract (2) costs from (1) revenues.


(1) Revenues: Revenues from sovereign debt carry trade (or dividends in the case of shares) go to the banks, not the ECB. This is because the ECB is simply lending sovereign debt rather than making outright purchases. Revenues from sovereign debt carry (in the case of 3yr Spanish bonds at 3.56%) ? (1) 3.56% carry in our example


(2) Cost: Banks borrow funds from the ECB, pledging sovereign bonds as collateral. They then pay interest to the ECB against those borrowings (repo cost). The interest rate for the loans is set at the policy rate which is currently 1%.

The cost to banks of borrowing funds from the ECB ? (2) 1% repo cost in our example


(3) Net profit: In our example, (1) revenues minus (2) cost results in net profit of 2.56% of borrowings for the bank (3.56% – 1.00% = 2.56%). The sovereign bond in our example will be redeemed three years hence, and the transaction will yield 2.56%. If sovereign bonds with maturities over three years are used as collateral, then the bank assumes corresponding yield risk up to the time of maturity.


(4) Risk: If, for instance, Spanish bond yields were to fall by more than 2.56% three years hence, thereby dropping below the 1.00% mark, then the respective bank would have enjoyed higher returns had it instead purchased from the open market and continued holding the bonds, rather than pledging them as collateral to the ECB. However, some take the view that such a low-yield scenario is fairly unlikely to happen, which may be why this arrangement is sometimes referred to as the "ECB carry trade."


(5) Scale: UBS forecasts that banks will borrow EUR 320bn through the LTRO facility. If that entire amount generated net profits for banks at a rate of 2.56% per our example, then the banking sector would reap annual profits of: EUR 320bn × 2.56% = EUR 8.2bn. That amount alone would improve the term profit and loss position of banks. Moreover, that amount would roughly double if LTRO demand comes in at EUR 600bn, the markets high estimate for the facility.


(6) Evaluation: However, profits on our EUR 320bn LTRO forecast is halved to EUR 4.1bn if we put the date to the end of June 2012, the deadline by which banks are subject to the core Tier 1 capital requirement of 9%. Accordingly, banks are going to fall short of the EUR 114.7bn recapitalization amount required by the EBA. This is a clear-cut example illustrating what we meant in yesterday's report in regard to the difficulties inherent in resolving the issue of bank undercapitalization through improvements in profit and loss conditions alone.


Conversely, if the EBA deadline were to be extended to 3 years, the same as the LTRO facility, banks could then generate EUR 8.2bn annually over three years, bringing their total to EUR 24.6bn, thereby generating earnings equivalent to 20% of the EUR 114.7bn amount. At any rate, LTRO will have more of a positive impact on term profit and loss if today's LTRO figure is significantly large, and if by some chance yields on sovereign debt that has been purchased by banks reach all-time highs.


(7) Japan's experience: The issue of bank undercapitalization looked at through the lens of what Japan has gone through reveals the importance of (1) achieving short-term solutions through investment of public funds, and (2) extending deadlines for achieving capital adequacy ratio targets. Japan's experience in the 1990s was similar in that the government's efforts to overcome the problem of nonperforming bank loans by gradually improving the term profit and loss position of its banks fell short due to the severity of bank undercapitalization. Consequently, the situation ultimately necessitated investment of public funds in 1998, and then again in 2003.


(8) Short-term market impact and strategies: Investor risk appetite would be stimulated and yields would rise if the LTRO facility were to exceed the estimated EUR 320bn amount, and also the EUR 600bn high-end forecast. However, even if that were to happen, it still would not be enough to resolve the previously noted issue of undercapitalization..

Summary - max profits thru the stress test deadline in a non-hypothetical situation €4.1 billion when there is a €115 billion hole to be plugged? And in reality, for a €210 billion carry trade the maximum profit is... €2.7 billion!? And the market ramps on this?

So can we please move on from the LTRO as the Deus Ex du jour now?



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prains's picture

Pissing into the wind

greased up deaf guy's picture

pennies in front of a rollercoaster? snark snark snark :-p...

Oh regional Indian's picture

Wasn't quite the shot heard around the world, but the Indian Rupee fell 20% against the dollar in the past 3 weeks.


With this kind of volatility, soon to spread to the more stable pairs.... carry trade is a big reason for so much FX manipulation. If/when a major fx event happens, feels like soon.... watch out below, carry traders.

And thank goodness. Carry trade skewed global finance into the hands of mercantilist kleptocrats.



Hansel's picture

Really?  ~500 billion in Decemeber, and they will do another LTRO in February.  What if it's for another 500 billion?  Maybe it becomes a regular thing.  April, June, August, October, December.  There's 3.5 trillion.  Is that pissing in the wind?

fonzanoon's picture

I agree Hansel. I think people are premature in their end of the world calls. We did QE, QE1, QE2, QE 2.5 we are probably doing QE right now. They will do LTRO in February, some more in June etc. etc. etc. They won't let things implode that easily. I hate it. But I think thats what will happen.

walküre's picture

When Bill Gross calls LTRO openly a "shell game" or "3 card monti" then it doesn't matter how many more times and how many more billions they throw into the fire. In the end the fire of hyperinflation will consume all paper.

Who cares that the banks survive to see another day when their collateral is just jack shit?

willien1derland's picture

Too true - what is frightening to consider is that yesterday's ZH post in which Marc Faber indicated that derivative contracts would be worth ZERO was more commentary than prophetic (all due respect to Mr. Faber!) Think about it- if we post to this blog knowing this, what of the banksters who 'trade' this sh*t?! Counterpart risk?! Really?! So a couple of banks issues bonds & receive government gtds to pledge at the ECB how much longer can this nonsense proliferate?

ThrivingAdmistCollapse's picture

There are derivatives FOR derivatives at this point.  The entire financial sector is so screwed up that collapse might be inevitable.

JPM Hater001's picture

Can someone please explain to me where the money came from?  All I get when I look it up is something a pixie dust and a short incantation by Ben Bernanke in the shower with Harry Potter.

amitmittal's picture

again the easy math refer our article yesterday. but to put it clearly. yes, the ECB put out this facility so no collateral is required for it to be retuurned Eur 289 bln and the rest is available for banks to pay back debt due in there!


GeneMarchbanks's picture

'Because the last thing Italian banks can afford is another late Novemeber blow out in yields which brought the system to within hours of imminent collapse.'

Fed will have to step in to buy sooner or later.

'And in reality, for a €210 billion carry trade the maximum profit is... €2.7 billion!? And the market ramps on this?'

Why you still use the word market without quotes is beyond me.

Stoploss's picture

See the pattern? This has become more and more internalized as it has less and less impact. Like a spinning top collapsing in on itself is what we are witnessing.

midgetrannyporn's picture could be made into a monster if we all pull together as a team.

Pink Floyd

Have a Cigar

JPM Hater001's picture

I am manually adding +13 since I only get 1.

My wife bought me front from to Roger Waters performing The Wall in June for my birthday.

PS.  I wasnt actually Birthed.  Ben printed me.

nobusiness's picture

First we need to ramp the US market to maximize yearend bonuses.

nobusiness's picture

I'm moving to Michigan.  Everything is wonderful there.

GeneMarchbanks's picture

Yes it is. The weather, affordable housing, friendly people and great opportunities.


GOSPLAN HERO's picture

There are many comrades in Michigan.

The Axe's picture

markets are broken    who cares....they make no sense at all!!!!

Tic tock's picture

It also covers euro deposits in Swiss Banks, is there a chart of Swiss Money supply vs. ES?


virgilcaine's picture

But the Euro trades below $130.00.. something isn't quite right.  With all of this banker confidence it should go up... Right?  

GeneMarchbanks's picture

€ = $130.00!

Clearly that is overbought. I'd feel safe shorting here with no fear of being stolperized...

Ignatius J Reilly's picture

"Yeah, that team sure did suck, Moe.  They were the suckiest sucks that ever sucked."  -Homer Simpson.

Ignatius J Reilly's picture

"If" this doesn't work, TPTB will blame it on the name.  "We should have called this TARP 2, the sequel!"

virgilcaine's picture

Roof diving from a flaming house in Detroit,  is a new sport.

spanish inquisition's picture

At this point, it looks to me like you would want to take the cash and position yourself with derivitives at banks that still have assets you can foreclose on.

mess nonster's picture

OK! here is the list of "Banks that still have assets you can foreclose on."






shit. I can't think of any.

spanish inquisition's picture

I think there might be one or two left to trade on. How many will be determined by MFG fall out. If the dude loses his gold stored at MFG to the trustee, next stop, safe deposit boxes.

Hey! New trade platform for rehypothication, using safe deposit box estimate of contents.

StychoKiller's picture

Hey! New trade platform for rehypothication, using safe deposit box estimate of contents.

Hmm, kinda like that reality show based on auctioning off abandoned storage lockers...

imapopulistnow's picture

A couple hundred billion here, a couple hundred billion there, it adds up.

Caviar Emptor's picture

Indentured Servitude Bonds: the only answer.

Eally Ucked's picture

This shit is insufficient for anything. Not for covering bank loses, not for rebuilding borrowing power of govs or to keep GDP numbers at proper level. All western countries GDP's depend on financial services to the tune of 30%. Those fake numbers will collapse and just imagine what will happen when that sector imput goes down, lets say 50%.

defn8Dog's picture

Well someone is buying US long bonds.  As the market rallies.

Everybodys All American's picture

The important note to remember is that the ECB did not print. Because Germany will not go there. The banks issued more bond debt of which the ECB agrees to hold as collateral. The ECB then have allows the banks to borrow back from them at a low interest rate with the hopes that they will buy sovereign debt. That is crazy all unto itself. But... What has been left out of the equation is that through currency swaps guess who ends up with the collateral?

JR's picture

As Gerald Celente says, “Hold onto your hat, your wallet, and your wits,” as well as “Plan to start saying goodbye to conventional liquid fuels!”  Here are a few of The Trends Research Institute’s Top 12 Trends 2012 posted on Lew Rockwell today:

1. Economic Martial Law: Given the current economic and geopolitical conditions, the central banks and world governments already have plans in place to declare economic martial law … with the possibility of military martial law to follow.

5. Technocrat Takeover: “Democracy is Dead; Long Live the Technocrat!” A pair of lightning-quick financial coup d’états in Greece and Italy have installed two unelected figures as head of state. No one yet in the mainstream media is calling this merger of state and corporate powers by its proper name: Fascism, nor are they calling these “technocrats” by their proper name: Bankers! Can a rudderless ship be saved because technocrat is at the helm?

6. Repatriate! Repatriate!: It took a small, but financially and politically powerful group to sell the world on globalization, and it will take a large, committed and coordinated citizens’ movement to “un-sell” it. “Repatriate! Repatriate!” will pit the creative instincts of a multitude of individuals against the repressive monopoly of the multinationals.

9. Big Brother Internet: The coming year will be the beginning of the end of Internet Freedom: A battle between the governments and the people. Governments will propose legislation for a new “authentication technology,” requiring Internet users to present the equivalent of a driver’s license and/or bill of health to navigate cyberspace. For the general population it will represent yet another curtailing of freedom and level of governmental control.

12. Going Out in Style: In the bleak terrain of 2012 and beyond, “Affordable sophistication” will direct and inspire products, fashion, music, the fine arts and entertainment at all levels. US businesses would be wise to wake up and tap into the dormant desire for old time quality and the America that was.

FreeNewEnergy's picture

Has anyone ever summoned up the temerity to say that Gerald Celente is full of shit?

Let me be the first. "Gerald Celente is full of shit."

The guy has an uncanny knack for covering up his lack of facts and accurate forecasts with excessive hyperbole.

He's been about as wrong as Steve Liesman is stupid. Put them both in a box, shake, and you come out with the modern economist: Mostly wrong and utterly clueless.

bpom's picture

"So can we please move on from the LTRO as the 'Deus ex fecesiae'" is facetiae.

mess nonster's picture

Ah, yes, the view from a mountain of zeros is...


The ECB is the poster child of pulling oneself up by one's own bootstraps, or

a mental picture of a perpetual motion machine

or a practical lesson in alchemy

or an experiment in quantum mechanics- does debt behave like profit only when observed? Is liquidity a wave phenomenon, or is it a particle, which makes it analogous to solvency?

Central Wanker's picture

Woefully insufficient to fix the balance sheets? Probably.

Nice addition to the bonus pool? Absolutely!

virgilcaine's picture

Tyler bankers don't like Math, no use for it ..this is a new era of finance you know.

JW n FL's picture




Let someone else do da Maff!


see how easy it is to let other people handle your MAFF! for Yous!


JW n FL's picture




Northern Trust Webcast

Webcast Date:
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10.00 UK, 11.00 CET
Presentation by:
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Northern Trust recently engaged in research to examine more closely the practical implications for investors of the evolving use of passive investments in institutional portfolios. In particular, our research highlighted some interesting trends, including:
• Investors’ expectations for using passive management in the future,
• The effect of increasing passive use on investment decision making,
• Current concerns about achieving efficient beta, and
• Opportunities for removing unwanted biases and inefficiencies in existing indexes

Maybe they share something useful? One can ALWAYS REMAIN HOPEFUL! the back peddling is getting OLD!

RobotTrader's picture

Bye bye gold


Under $1,600

Another "Angel" getting gangraped.

"If I had only bought SPG instead.  $30 to $130 non-stop in 3 years with no corrections whatsoever.

And receiving dividend payments to boot.