While the LTROs were supposed to bring European banks back from the edge of insolvency with a warming blast of liquidity, the sad truth, now that the exuberance of fresh money-printing has faded, is that the unintended consequence has crammed down the senior unsecured bank debt holders to the lowest of the low. This realization, that we have discussed a number of times - most recently here - that nothing has been solved [6] - as the LTRO Stigma unintended consequence, is starting to leak back into broader risk premia as now the contagion risks are back on the table and even non-LTRO-facing banks are seeing spreads increase as expectations of either broader forced cram-downs or interconnected vicious cycles rear their ugly head once again among European banks - and implicitly back onto European Sovereign balance sheets. Citigroup's Hans Lorenzen highlights four key reasons for the increasingly binary bifurcation that senior unsecured bank debt has become.
Step 1: Vicious Cycles in Financial, Sovereign, and 'Real Economy' - briefly stymied by LTRO Hope but last week's macro data indicates the ongoing negative feedback loop between Austerity and Economic Contraction continues...
[7]
Source: Barclays
Step 2: LTRO fixed short-term liquidity issues in hopes of solving long-term insolvency issues but in the meantime the unitended consequence crammed down existing unsecured creditors...
[8]
Source: Citi
Step 3: But this has led to the LTRO Stigma as this cram-down and subordination was priced into LTRO-facing banks first (the LTRO Stigma that Draghi lied and said was not present) and now is creeping across into non-LTRO facingbanks as the vicious cycle from above starts to re-appear - as we also note the last week or so that short-term EUR-USD basis swaps have stabilized (stopped improving) and in fact 1Y basis swaps have started to deteriorate once again...
LTRO Stigma has exploded and non-LTRO banks are starting to creep wider too...
[9]
And perhaps more worryingly EUR-USD basis swaps are starting to creep weaker once again...
[10]
Chart: Bloomberg
Step 4: Leaving unsecured bank debt holders with a very binary payoff as the four realities of the new rules in Europe will surely leave non-government investors questioning the investment:
As a Bank bondholder:
- You now sit towards the bottom of the capital structure
- You're in a much thinner slice than you used to be
- The quality of your asset pool has deteriorated
- The correlation of your asset pool has risen sharply
Source: Citi
All-in-all - The LTRO stigma trade seems the best way to play and its becoming a major driver of equity performance as Italian banks hit YTD lows.