LTRO - Scratching The Surface

Tyler Durden's picture

Via Peter Tchir of TF Market Advisors,

Now that the hype of LTRO is over (for now) people are starting to focus on the details and some of the potential consequences.  This is a first cut based on bits and pieces from various LTRO documents released by the ECB.  I haven’t seen anything that resembles a document fully describing the current LTRO’s, but am trying to find it, and will refine this analysis as more details come to light.


Repayable in 1 year


This isn’t a big deal, but helps explain why banks would have taken money to create a safety net for themselves.  The loans are 3 years in maturity, but are repayable in a year.  That prepayment right is an important factor in why the demand was so high.  The LTRO is actually a floating rate loan – it is not fixed.  It will move roughly in line with the ECB’s short term rate.  Right now that is at 1%, but in theory could be increased.  Banks that were borrowing “preemptively” under the facility will value the 1 year prepayment rights.  If the loans became expensive as rates rose, and they didn’t need the money, they could just repay the loans.


Floating Rate


The loans have a 3 year maturity, but it seems as though the rate paid will be reset periodically in a way that should track the ECB overnight rate.  That isn’t exactly how it is described, but seems to be the jist of it.  With the Fed on hold until 2014 and the ECB under Draghi much more accommodative, it seems likely the rate will remain low, but it isn’t guaranteed.  That puts a slight damper on the “carry trade” enthusiasts.  Italian 2 year bonds yielding 1.78% aren’t that appealing, especially if the funding cost can increase.


Variation Margin


Zerohedge pointed out a spike in additional collateral being posted at the ECB.  According to some documents, the ECB is required to impose variation margins on its financing operations.  This means that the collateral posted is not a one-time deal.  If the collateral a bank has posted declines in value, the banks would have to post additional collateral.  This is a big deal.  Somehow the world seems to have an image that banks can borrow 3 year money at 1%, pledge an asset against it, and let the carry take effect with no other consequences.  That is far from the truth if variation margins are being used.

Having to post variation changes the product a lot.  Buying longer dated bonds becomes very risky.  They remain volatile and although banks could hold them in non mark to market books to avoid that volatility hitting their P&L, it wouldn’t save them from posting variation margin if the holdings decline in value.  That helps explain why the curves are so steep, and really will limit the ability of banks to hold down longer term yields if we get another round of weakness, the death spiral risk is too scary.

Portuguese banks should be of particular concern – again.  The 2 year Portuguese bonds have jumped from a price in the low 80’s to the low 90’s.  If banks bought these bonds as LTRO the potential for death spirals is on.  As the bonds start declining in value, the banks would have to post collateral.  Since the Portuguese banks are surviving almost exclusively on central bank money, their only choice would be to pledge some unpledged assets (if they have any), or sell the bonds and try and repay some of the LTRO.  Selling bonds would put additional pressure on a then weak market.  So the banks will pledge more assets.  This does nothing to stop the slide in the underlying bonds, but would subordinate senior unsecured debt holders further.  Senior unsecured debtholders will run for the hills again.  They will see assets being taken out of the general pool – where they have a claim – and get shifted to the ECB, where ECB has the first rights. 

Like anything else, once this becomes a concern in Portugal, the contagion fear is likely to raise it’s head.  With €1 trillion of assets part of the LTRO program, even a 2% decline in assets pledged, would require banks to pledge 20 billion of additional collateral.  Italian 2 year bonds have jumped 10 points since LTRO.  Is that sustainable?  Is there no risk they drift down again?  Variation margin is leverage at the extreme.  It creates risk to the mark to market of the underlying assets, and makes the “carry trade” option far less interesting, or more scary for any institution that has prudent risk management.  Ah, yes, that explains why LTRO dependent banks and those most interested in playing the “carry” game are trading weaker than their peers – they are demonstrating that they are not prudent.

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battle axe's picture

Why does this sound more and more  like a runaway train that no one can stop....

JPM Hater001's picture

Ron Paul can stop it.

I heard Chuck Norris is his bitch.

SheepDog-One's picture

No one can stop a runaway train, but it will crash spectacularly 100% certainty.

valley chick's picture

forget popcorn .....time for Good & Plenty!


cue 1950's Good and Plenty Choo Choo Charlie jingle...

Benjamin Glutton's picture
Spain's sovereign thunderclap and the end of Merkel's Europe


The Spanish rebellion has begun, sooner and more dramatically than I expected.

As many readers will already have seen, Premier Mariano Rajoy has refused point blank to comply with the austerity demands of the European Commission and the European Council (hijacked by Merkozy).

Taking what he called a "sovereign decision", he simply announced that he intends to ignore the EU deficit target of 4.4pc of GDP for this year, setting his own target of 5.8pc instead (down from 8.5pc in 2011).

In the twenty years or so that I have been following EU affairs closely, I cannot remember such a bold and open act of defiance by any state. Usually such matters are fudged. Countries stretch the line, but do not actually cross it.

With condign symbolism, Mr Rajoy dropped his bombshell in Brussels after the EU summit, without first notifying the commission or fellow EU leaders. Indeed, he seemed to relish the fact that he was tearing up the rule book and disavowing the whole EU machinery of budgetary control.

He is surely right to seize the initiative. Spain’s economy will contract by 1.7pc this year under his modified plans and unemployment will reach 24pc (or 29pc under the 1990s method of counting). To compound this with manic fiscal tightening – and no offsetting devaluation – is intellectually indefensible.

There comes a point when a democracy can no longer sacrifice its citizens to please reactionary ideologues determined to impose 1930s scorched-earth policies. Ya basta.

What is striking is the wave of support for Mr Rajoy from the Spanish commentariat.

This one from Pablo Sebastián left me speechless.

My loose translation:

"Spain isn’t any old country that will allow itself to be humiliated by the German Chancellor."

"The behaviour of the European Commission towards Spain over recent days has been infamous and exceeds their treaty powers… these Eurocrats think they are the owners and masters of Spain."

"Spain and other nations in the EU are sick and tired of Chancellor Merkel’s meddling and Germany’s usurpation – with the help of Sarkozy’s France and their pretended "executive presidency" that does not in fact exist in EU treaties."

"Rajoy must not retreat one inch. The stakes are high and the country is in no mood to suffer humiliations from a Chancellor who is amassing all the savings of Europe and won’t listen to anybody, as if she were the absolute ruler of the Union. Merkel and the Commission should think hard before putting their hand into the sovereignty of this country – or any other – because it will be burned."

This then is the fermenting mood in the fiercely proud and ancient nation of Spain in Year III of depression, probably the worst depression the country has seen since the 1640s – or have I missed a worse one?

As for the "Fiscal Compact", it is rendered a dead letter by Spanish actions.

Gracias a Dios. If the text were enforced, the consequences would be ruinous. It enshrines Hooverism in EU law, and imposes contractionary policies without the consent of future parliaments – including any future Bundestag. Indeed, it probably violates the German constitution.

But it won’t be enforced in any meaningful sense because the political realities of the EU are already intruding, and will intrude further. A president François Hollande of France will rip it up.

The Latin Bloc is awakening.

battle axe's picture

"President Francois Hollande will rip it up". Yup and when that happens the shit will really hit the fan. Bye Bye Euro.

oogs66's picture

I hope Spain does what it says, but I suspect there will be a technocrat appointee before the year is done :(

RSloane's picture

Thanks for your post. It adds more flesh to the EU skeleton that we're supposed to pretend is able-bodied.

francis_sawyer's picture

Time to check the sofa cushions again...

SheepDog-One's picture

Oh...time to check the pulse of all the funny money floatin around now. Is it alive yet?

fonzannoon's picture

Does anyone else read this stuff and just say "what the fk is going on?" I mean like really what the fk is all this about? Borrow at this, pledge that, pay this, but it can go up...and people like Peter who I am sure is a good guy actually tries to evaluate this stuff and it's legitimacy...If this is not pure insanity I don't know what is.

SheepDog-One's picture

Bottom line to me its just wanking. Buying a bit of time. Too bad there are no grownups in the world, just these sick insane lunatics who run everything.

fonzannoon's picture

I agree. I just would never believe that you can have a continuous situation where small groups of people make up rules and change them as they go along and the markets have faith in it.

SheepDog-One's picture

I just like Tylers ad for 'Sugar Daddy Dating'....we're RICH, and need 15 year old lookin bitchez! I guess.

tarsubil's picture

I got that too. Makes me feel creepy (-er). I think I got that because I clicked on a related story on Drudge. Such a sad world we live in.

oogs66's picture

I think million dollar bonus must click those adds every time they show up since they seem to be increasing in frequency

PaperBear's picture

After reading the recent 'BIS:Clearing CDS through a CCP' post I have a dumb question regarding Interest Rate Swaps.

While I understand that CDS protection bought should be considered an 'asset' and CDS protection sold should be considered a 'liability', what the hell are IRS 'pay fixed' and IRS 'pay floating' ? Which is an 'asset' and which is a 'liability' ?

Central Bankster's picture



Thanks for the clarity on what you meant by margin calls on sovereign bonds by the LTRO.  In your article last night, it wasn't clear "how" the LTRO could cause a spiral of collateral calls.

WaEver's picture

Nice resumé. Anybody has an idea on the impact of the risk-weighting of Spanish,Portugese or Italian Govies or has this become irrelevant in this carry-trade fairytale (wonder where Grumpy has gone.....)

tarsubil's picture

Liebermen, "How dare Assad murder Syrians! That's our job!"

chinaboy's picture

With €1 trillion of assets part of the LTRO program, ECB can also use variation margin to manipulate the market. Then all that means is that European is totally commie inside. Include North Korean data if you are a fix income quant. How long they can play it? How long you can win by "no fighting with ECB"?

beaker's picture

They're going to keep winging this shit until they can't anymore.  It works until it doesn't.  There is no upside in just throwing in the towel and saying it doesn't work.  It is like being in a losing chess game where you are just trying to postpone checkmate.