We have discussed forecasts for the second (and certainly not last ) February 29 3 Year LTRO in the past, with expectations for its size ranging from €1 trillion [15] all the way up to a mindboggling €10 trillion [16]. Today, Goldman has conducted a poll focusing on investors and banks, to gauge the sentiment for what has over the past 2 months been taken as the latest Deus Ex, which is really nothing than yet another bout of quantitative easing, only one in which the central bank pretend to be sterilizing 3 year loans by accepting any and virtually all collateral that banks can scrape off the bottom of their balance sheets (as a reminder, back in the financial crisis, Zero Hedge discovered that the Fed was accepting stocks of bankrupt companies [17]as collateral - certainly the ECB is doing the same now). And once the banks get the cash instead of lending it out, or using it for carry trades, they simply use it to plug equity undercapitalization due to massive asset shortfalls on their balance sheets which are mark-to-unicornTM, yet which generate zero cash flow, even as banks have to pay out cash on their liabilities. In essence, the banks convert worthless crap into perfectly normal cash with the ECB as an intermediary: and that is all the LTRO is. Luckily, as we pointed out, even the idiot market is starting to grasp the circular scam nature of this arrangement, and the fact that it is nothing short of Discount Window usage, and because of that, the stigma associated [18]with being seen as needing this last ditch liquidity injection is starting to grind on the banks. It is only a matter of time before hedge funds create portfolios in which they go long banks which openly refuse to use LTRO cash, and short all the other ones (read every single Italian and Spanish bank out there, and most French ones too) because at the end of the day one can only fool insolvency for so long. But once again we are getting ahead of the market by about 3-6 weeks [19]. In the meantime, and looking forward to the next LTRO, whose cash will be used exclusively to build up "firewalls" ahead of the Greek default, here is what Goldman's clients expect to happen...
LTRO II: Investors expect €680 bn take-up, banks €562 bn taking LTRO total >€1 tn
Second and final three-year LTRO: Feb 28
The ECB’s first three-year LTRO auction in December resulted in a record (€498 bn) take-up. The second and final auction is planned for February 28; ahead of it, expectations are wide. To add clarity, we carried out an LTRO poll aimed at investors and the EU banks under our coverage. We received 343 responses from investors and 15 responses from banks (we cover 50 EU banks).
Take-up expectations exceed €0.5 tn…
Investors’ average expectation is for an aggregate take-up of €680 bn; banks that responded to our poll expect €562 bn. If these expectations materialize, the ECB will end up injecting €1.1 tn - €1.2 tn of three-year funds. At the bottom end of the range, this is the equivalent to 141% of 2012 and 78% of 2012-13 European bank bond maturities. It is also 6% of total Eurozone loans outstanding.
… due to expanded collateral, pricing
Banks see “attractive pricing” as a key reason to participate; investors “expanded collateral pool” [read any piece of worthless crap that is not nailed down]. The stigma has disappeared Our poll indicates that the ECB’s efforts to reduce the stigma related to its facilities have been successful. Investors perceive high take-up to be positive for bank share prices.
Average aggregate take-up expectation: Investors expect €680 bn, banks €562 bn
See Exhibit 1
Investors’ average expectation is for €680 bn of aggregate take-up; banks that responded to our poll expect €562 bn. Interestingly, the range of answers from investors is substantially wider (€300 bn-€1 tn) when compared with banks (€500 bn - €1 tn). This creates a partial mis-match between the expectations of banks and investors. Note that 40% of all surveyed investors expect a take-up exceeding €750 bn, compared with only 7% of surveyed banks.
If these expectations materialize, the ECB will end up injecting €1.1 tn - €1.2 tn of three-year funds into the Eurozone banks. At the bottom end of the range, this is the equivalent to 141% of 2012 and 78% of 2012-13 European bank bond maturities. It is also 6% of total Eurozone loans outstanding.
In that case, the ECB action will have substantially enhanced the stability of the European financial system.
Primary reason for participation: Attractive pricing and expanded collateral pool
See Exhibit 3
73% of banks in our sample see attractive pricing as a key reason for another strong take-up, followed by an expanded collateral pool (20%). Investors don’t seem to have a strong view; while expanded collateral pool is the most popular answer (36%), attractive pricing and reduced stigma, at a respective 31% and 27%, show a split view.
Use of funds: Paying down existing debt
See Exhibit 4
Both investors (56%) and banks (57%) expect the primary usage of funds to be paying down outstanding bank bonds, while initiation of new sovereign bond carry trades is only expected by a minority. Increasing lending to customers proved to be at the bottom of the expectations list, with only 4% of investors and 7% of responding banks choosing it as a primary use of new ECB funds.
Were these expectations to prove accurate, the implications would be far reaching:
- Firstly, a paydown of debt on a large scale would result in a reinvestment dilemma for current holders of European bank debt. Insurance companies, pension funds and large AM firms would need to find alternative investment opportunities. The scale of European bank bonds, as an asset class, is so large that it is comparable only to sovereign bonds or the combined size of all other non-financials corporate bonds outstanding.
- Secondly, it is indicative of the NIM expansion to be led by a reduction in the average cost of liabilities rather than a pick-up in asset spread (i.e. the carry trade).
Effects of the LTRO
See Exhibit 5
Investors and banks expect the LTRO to have a broad effect ranging from reduced funding costs, increased profitability and a slower pace of deleveraging. Importantly, while participants agree that the pace of deleveraging will slow, neither banks nor investors foresee the LTRO resulting in outright loan growth. This is consistent with investor/bank expectations that the primary use of funds will relate to reducing outstanding stock of bank bonds.
Impact on sentiment and share prices
See Exhibit 6-8
A large take-up (defined as >€500 bn) is seen as overwhelmingly positive for bank share prices (75% of investors/80% of banks agree on this). Furthermore, 57% of investors and 73% of responding banks see the ECB’s LTRO as a “game changer”, on par with the TARP programme in the US.
Finally, the banks’ expectation is that this LTRO is the final one, which supports their intent for large participation. Additionally, it could also express the view of sufficient funds in the system to guarantee longer-term stability. Half of the investors, however, see probability of further LTROs in the future as high, likely highlighting continued reservations as to the overall stability of the European financial system.
And the pretty exhibits:
[20]
[21]
Needless to say, none of these "conventionally accepted" things will happen. What will happen, is that the ECB's balance sheet will explode by another €1 trillion, and will account for nearly 40% of European GDP, banks will hunker down in anticipation of the Greek default, and everyone will pray that the cash will be sufficient to last through any and all unexpected consequences of first a Greek, and then a Portuguese default (and so on). However, as Lehman taught us, the cash will be woefully insufficient, and the Fed will have to step in and provide another $5-10 trillion, and maybe much more, in liquidity to prevent another systemic disintegration.
That is all.