Liquidity Isn't Capital
At the start of April, ECB's Draghi noted, "let's keep in mind that it [the LTRO] is not capital", adding that "if a bank does not have capital, it would be better to raise it now". Given the rapidly fading glow of LTRO's liquidity flush, the seemingly 'wasted' ammunition that Spanish and Italian banks have fired at the sovereign bond bears and the complete and utter lack of capital raising that has occurred, perhaps it is no wonder that credit spreads on the major European financials have exploded back to near their wides once again (LTRO-encumbrance aside). As Barclays notes today, the major financials alone look set to need over EUR120 billion in capital to bring their credit risks down to acceptable levels to be able to openly access capital markets once again. This means a median 30% of current equity market capitalization has to be raised. Just as we pointed out again and again, not only is the LTRO an encumbrance of bank balance sheets (and therefore increasingly subordinates all existing bond-holders implicitly reducing recoveries in a worst case scenario) but it delayed much-needed decision-making by giving the banks an 'out' for a few months.
The sad reality now is that liquidity is simply not capital and given the decompression in senior credit spreads, subordinated credit spreads, and the surge in LTRO stigma (as well as huge compression in equity prices), it seems the investing public is also seeing this. Either banks shrink their balance sheets dramatically (with the ensuing credit contraction driving Europe into a much deeper recession) or they raise capital, hugely diluting existing shareholders (since we can only imagine who would be willing to fund these black holes at anything like current market prices). To rub a little further salt into that wound, tomorrow will bring ECB margin calls and given the collapse in Italian and more so Spanish bond prices, there has to be some anxious margin clerks making calls right now given the ridiculously fine haircuts that were imposed on these bonds.
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