LCH Hikes Margin Requirements On Spanish Bonds

Tyler Durden's picture


A few days ago we suggested that this action by LCH.Clearnet was only a matter of time. Sure enough, as of minutes ago the bond clearer hiked margins on all Spanish bonds with a duration of more than 1.25 years. Net result: the Spanish Banks which by now are by far the largest single group holder of Spanish bonds, has to post even more collateral beginning May 25. Only problem with that: it very well may not have the collateral.

And as a reminder: Ponzi PatriotismTM

Finally, tying it all together is our post from late April, titled The Next Circle Of Spain's Hell Begins At 5% And Ends At 10%:

Three weeks ago we discussed the ultimate-doomsday presentation of the state of Spain which best summarized the macro-concerns facing the nation and its banks. Since then the market, and now the ratings agencies, have fully digested that meal of dysphoric data and pushed Spanish sovereign and bank bond spreads back to levels seen before the LTRO's short-lived munificence transfixed global investors. However, the world moves on and while most are focused directly on yields, spreads, unemployment rates, and loan-delinquency levels, there are two critical new numbers to pay attention to immediately - that we are sure the market will soon learn to appreciate.

The first is 5%. This is the haircut increase that ECB collateral will require once all ratings agencies shift to BBB+ or below (meaning massive margin calls and cash needs for the exact banks that are the most exposed and least capable of achieving said liquidity).

The second is 10%. This is the level of funded (bank) assets that are financed by the Central Bank and as UBS notes, this is the tipping point beyond which banks are treated differently by the market and have historically required significant equity issuance to return to regular private market funding. With S&P having made the move to BBB+ this week (and Italy already there), and Spain's banking system having reached 11% as of the last ECB announcement (and Italy 7.7%), it would appear we are set for more heat in the European kitchen - especially since Nomura adds that they do not expect any meaningful response from the ECB until things get a lot worse. The world is waking up to the realization that de-linking sovereigns and banks (as opposed to concentrating that systemic risk) is key to stabilizing markets.

UBS: A 10% Tipping Point

Greater ECB use defers the point at which a sovereign or bank faces a funding challenge, but accelerates the point at which a return to private market financing is unlikely without external support. We continue to see a level of 10% of funded assets financed at the central bank as a tipping point beyond which banks are treated differently by the market and have historically required significant equity issuance to return to regular private market funding. Spain’s system just passed this figure, reaching 11% with the most recent announcement of ECB drawings



And a 'bad bank' ahead...


We believe that Spain will need an EU program to raise sufficient funds for what we believe needs to be significant further support for its banks and to provide external verification to regain credibility in the resulting financial system. A ‘bad bank’ to deal with the €323 billion in real estate assets is necessary, but not sufficient, in our view: the €545 billion shortfall in domestic savings compared with loans is likely to demand a “funding bank” in addition. We would view the likely loss content of this large headline to be a significant but smaller €100 billion.

Nomura: De-linking sovereigns and banks is key to stabilising markets

The most effective response for Spain would be to de-link sovereigns and their banks, following recent steady accumulation of sovereign debt by peripheral banks, in our view. Reducing the link between Spanish banks and the sovereign remains one of the key aspects for relieving pressure on Spain, whether this be by removing sovereign debt from balance sheets or ensuring sufficient capitalization to absorb losses. Unemployment out this morning at 24.4% shows the fragile state the economy is in, which is likely to keep pressure on Spanish yields. Against this backdrop the effect on the asset side of balance sheets is concerning, with expected weakness in non-core government bond prices coupled with a weak economy decreasing individuals' and corporates' ability to repay


If all agencies downgrade Spain to BBB+ or below, the ECB could increase haircuts by 5% on SPGBs


The key aspect in terms of the Spanish downgrade(s) is the ECB's LTRO. If all three rating agencies move Spain to BBB+ or below then under the ECB's current framework it moves into the Step 3 collateral bucket which requires an additional 5% haircut across the maturities. In classifying its risk management buckets, the ECB uses the highest of the ratings to determine an asset's position (unlike the sovereign benchmark indices which use the lowest rating, in general). Fitch and Moodys currently rate Spain at A and A3 respectively, with both having a negative outlook in place leaving only a small downgrade margin before Spain migrates to the lower ECB bucket.


Italy's position is marginally more precarious in that it shares Spain's A3 rating from Moody's but is rated lower at A- by Fitch, and is similarly outlook negative from both agencies. One would hope ECB pragmatism would prevail and move to be more accommodative on its collateral haircut rules on sovereign debt.


The weakness of the eurozone's growth outlook is undermining the efforts of many sovereigns to rein in budget deficits, thereby highlighting the self-defeating nature of the fiscal compact as currently defined. Including the political impact, this has potential to lead to further downgrades



LTRO funding is not suitable when collateral values are unstable LTRO, like all repo funding, should only have been implemented with quality assets to avoid excessive margin calls. In 2009-10, when the operations were used to good effect, the majority of European sovereign assets were still perceived to be 'risk free'. 5-year SPGBs rallied from 4.95% in mid-2008 to 2.62% in December 2009 and non-performing loans were at roughly half of their current levels. In 2009, despite economic weakness, risk had generally been contained through continued fiscal programs, and with the ECB providing continued cheap funding it was sufficient to allow some normalization. The key difference between then and now is that sovereigns no longer have the ability to utilize the fiscal side. When the ECB announced the twin LTROs at the end of last year the sovereigns were clearly in a different state from 2009.


If the ECB believes in the mandated reforms it should be comfortable with warehousing sovereign risk


If the ECB believes in the currently prescribed course of reforms and their implementation it should have little issue with holding a major sovereign's collateral on its balance sheet. Taking this a step further, the ECB is generally concerned with moral hazard, which along with subordination, is likely also a reason why we have yet to see the SMP program buying bonds recently. But this is a double-edged sword in that it gives investors little confidence in the sovereigns' recovery prospects if the central bank appears to be in internal turmoil and is showing no action besides utilizing measures that are more suited to a strengthening market. One of our common refrains during the crisis is that moral hazard should not frame the reaction function of central banks. Rather, the over-riding and immediate objective of policymakers during a crisis needs to be avoiding non-linear or dual equilibrium risk. This requires aggressive and bold policies to be enacted. Europe's policymakers have notably failed on this front, and, hence, we have a crisis that has entered its third year.



The ECB’s discomfort is no comfort to investors, eroding confidence


The key question remains in Spain as to who is the marginal buyer of debt beyond the domestic banks and primary dealers. Although the Spanish Treasury has sold a significant amount of its 2012 requirements, as things currently stand the country faces a multi-year funding problem. The extent to which domestic savings filtering through to bond buying is limited given that the general level of savings is likely at its limit. Banks, Santander and BBVA, have also said that they have no more capacity for further sovereign bond purchases given they are at the limit of their risk concentration limits (link), which we think was rather diplomatically put. One risk is that domestic institutions shorten their SPBG holdings and focus more on bills, which would likely be unaffected by any debt restructuring.


We will see a worse situation before any meaningful response is produced by the ECB: QE


Our view is that things will get significantly worse before any meaningful policy response occurs. From the ECB?s perspective this entails pre-announced QE in a size which is commensurate to the problems faced. If the ECB believes in the actions taken by sovereign governments, which it has largely mandated, then its current responsibility is to stabilize sovereign markets in order to facilitate sovereigns' continued financing. The key inhibitor is the deterioration in the political union and the consequent ability to formulate a political response. Absent a proportional policy response, euro breakup remains more probable than possible at this juncture.

Key takeaways for us are:

  • the 5% haircut that will force margin calls on the most cash-strapped banks;
  • the 10% funding level beyond which the ECB's intervention in the banking system becomes restrictive and self-defeating;
  • LTRO funding is not suitable when collateral values are unstable LTRO, like all repo funding, should only have been implemented with quality assets to avoid excessive margin calls;
  • greater ECB use defers the point at which a sovereign or bank faces a funding challenge, but accelerates the point at which a return to private market financing is unlikely without external support;
  • and finally, the most effective response for Spain would be to de-link sovereigns and their banks, following recent steady accumulation of sovereign debt by peripheral banks, in our view.
Your rating: None

- advertisements -

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Fri, 05/18/2012 - 13:43 | 2440852 jcia
jcia's picture

Adiós amigo.

Fri, 05/18/2012 - 14:28 | 2441010 NotApplicable
NotApplicable's picture

Here's an interesting article about recent credit spread blowouts and how they also preceded the infamous flash-crash. Somebody over at Marketwatch better tell Mr. Gayed they don't like these "stocks are at serious risk" kind of articles. It's like the guy reads ZH or something.

Fri, 05/18/2012 - 22:26 | 2442674 Buck Johnson
Buck Johnson's picture

And so it begins, we will see an implosion before the elections.

Fri, 05/18/2012 - 13:43 | 2440853 slewie the pi-rat
slewie the pi-rat's picture

incest is all right as long as you keep it in the family, BiCheZ!

Fri, 05/18/2012 - 13:44 | 2440854 Colombian Gringo
Colombian Gringo's picture

An avalanche of worthless Spanish Paper is about to tumble. Look out below, they ain't Tapas coming at you!

Fri, 05/18/2012 - 13:43 | 2440855 bdc63
bdc63's picture

It really is starting to feel that this is coming to a head ... wonder how much longer they can keep all the balls in the air...

Fri, 05/18/2012 - 13:45 | 2440861 Colombian Gringo
Colombian Gringo's picture

They are already dropped, just most people refuse to recognise it.

Fri, 05/18/2012 - 13:53 | 2440882 El Oregonian
El Oregonian's picture

Improper wording ... You should NEVER unintentionally use "Head and Balls" in the same sentence. Just say'in...

Fri, 05/18/2012 - 13:46 | 2440865 l1b3rty
Fri, 05/18/2012 - 13:47 | 2440866 Frank N. Beans
Frank N. Beans's picture


Fri, 05/18/2012 - 13:48 | 2440869 Cognitive Dissonance
Cognitive Dissonance's picture

That can't be good......can it? Better call my broker and find out. :)

Fri, 05/18/2012 - 13:51 | 2440877 carbonmutant
carbonmutant's picture

He's probably watching CNBC for the latest on FB...

Fri, 05/18/2012 - 13:50 | 2440875 El Oregonian
El Oregonian's picture

Gosh! this daily dose of douche is killing me... I'm sure there's a pile of shit under every stone of valuation out there. The lemmings continue to chase each other off the cliff. I'm going to grab my PMs, hang out at the beach, and drink a cool one deciding if I want to take a swim... oh wait, radiation from Fukushima just showed up... DAMN!!!

Fri, 05/18/2012 - 13:53 | 2440881 midgetrannyporn
midgetrannyporn's picture

That's easy. The banks forgive the gubbermint debt and the gubbermint places the banks into receivership. Call me the problem solver.

Fri, 05/18/2012 - 13:56 | 2440885 Poetic injustice
Poetic injustice's picture

They have run out of toilet paper and used chewing gum to post as collateral?

Fri, 05/18/2012 - 14:05 | 2440930 junkyardjack
junkyardjack's picture

I hear China is in the market for concrete if they want to start ripping up their streets...

Fri, 05/18/2012 - 13:57 | 2440891 emersonreturn
emersonreturn's picture

admittedly, i am dazed...but aren't a few french banks rather handsomely invested in spanish banks?

Fri, 05/18/2012 - 13:58 | 2440893 Jean
Jean's picture

 it very well may not have the collateral.

Sure they have the collateral, they will just issue more short term bonds.


BTW:  I hope that it is a silly rumor that some Euro states have put up 30d border controls

Fri, 05/18/2012 - 14:01 | 2440911 timbo_em
timbo_em's picture

Anyone got an idea what might happen if or rather when Spain and Italy lose their investment grade? Iceberg dead ahead, Sir!

Fri, 05/18/2012 - 14:10 | 2440948 Jean
Jean's picture

Isn't it de facto at this point, who the hell is still into them long? other then the political banks.

Fri, 05/18/2012 - 14:03 | 2440922 Winston Churchill
Winston Churchill's picture

Long; Duct tape and baling wire.

Fri, 05/18/2012 - 14:18 | 2440969 LongSoupLine
LongSoupLine's picture

It's over's over!

Fri, 05/18/2012 - 14:24 | 2440992 geewhiz190
geewhiz190's picture

great call

Fri, 05/18/2012 - 14:35 | 2441059 smb12321
smb12321's picture

Every nation in the world is doing the same thing - becoming the primary holder of sovereign debt.  This is NOT like previous times when individuals bought a huge chunk of debt (treasuries). They have disappeared.  Primary holders are now the FED, BOE, EU (through the clumsy loan-for-bond bank transfers) and even the BOJ.  

Another case of a snake consuming itself, printing money to buy more debt. 

Fri, 05/18/2012 - 14:44 | 2441138 Scalaris
Scalaris's picture

If anyone's looking for quality collateral, I have some FaceBook shares available.

Face me in tweetbook if interested.

Fri, 05/18/2012 - 14:47 | 2441167 tradewithdave
tradewithdave's picture

Clearing houses are "the new black."

Fri, 05/18/2012 - 21:15 | 2442538 zippy_uk
zippy_uk's picture

Oh dear - we appear to have run out of Euros. Will you take lemons instead ?

Sun, 05/20/2012 - 17:50 | 2445839 jonytk
jonytk's picture

But can't they buy more bonds and use it as a collateral??

Ah the damn rating agencies downgraded it, they're the problem de-railing the MoneyASdebt world!!!

Do NOT follow this link or you will be banned from the site!