Removing The FDIC's TLGP Crutches Results In A Major Funding Cost Divergence

Rewind to March of this year when not even Goldman Sachs could issue non-FDIC guaranteed debt, (thank you TLGP). Of course, now that the Fed has made its one purpose in life to print enough money to irreparably clog every traditional risk measure, the TLGP program is presumably no longer needed (although a few banks did catch the last possible TLGP issuance window just at the program was being wound down). One question that deserves an answer is when will the banks that have borrowed cheap TLGP funds repay these? After all, the banking system is now "perfectly solvent," so it should be a formality for them to return all the money that is being guaranteed by taxpayers. This is especially true at Goldman, which is about to pay over $20 billion in bonuses, yet still has almost $30 billion in TLGP funding on its books: that's more than enough to cover each bonus dollar. Maybe Goldman can truly do god's work on earth and instead of paying bonuses simply repay taxpayers by retiring the firm's TLGP borrowings? Of course, we can dream.

What is more curious is the rather dramatic dichotomy that has emerged as a result of the TLGP program's expiration, and subsequent fund raising efforts. While some banks, namely those that have a depositor base, have demonstrated an ability to raise capital at spreads comparable, if not tighter to TLGP spreads, others have not been so lucky. We present the US Bancorp - Morgan Stanley case study.

As the example below demonstrates, both USB and MS issued TLGP debt on March 10 with the same coupon, at almost the same spread (87 bps for a $2 billion issue for MS, 81 bps for a $750 million issue for USB). Yet a few days ago, both banks, once again concurrently, raised a non-guaranteed senior issue: what is notable is that while USB managed to complete this round at a spread even tighter to its TLGP issue, Morgan Stanley gave up 120 bps in the process: USB's new $500 million issue came out at 80 bps, while Morgan Stanley had to go all the way to 205 bps to find buyers!

The incremental cost for Morgan Stanley: $24 million a year. This is almost enough to pay the bonus of a Goldman bond trader. Of course, added up this spread differential could end up amounting to quite a material number. The question at hand is who does the market now see as a first and as a second tier financial firm: Morgan Stanley, which does not have a depositor base despite it BHC moniker, seems to suffer as a result of it having become a poor man's Goldman Sachs. This will likely impair it and its peers for the future, as deposit-based banks continue procuring beneficial market terms.

Moody's had the following to say on this divergence:

Although this is just one example, to the extent such funding cost differences persist over time, lower-rated U.S. financial institutions will be at a competitive disadvantage that may be material. The disadvantage would reinforce rating distinctions among firms, all else being equal. We also note that, for many smaller firms, market access is still not what it had been prior to the current financial crisis. The competitive disadvantage for those institutions might be even greater.

And, it goes without saying, that cheap credit will only continue up to such a point that the Fed decides it is time to commence tightening the trillions in excess liquidity. Then again, the probability of that happening in our lifetimes is very, very slim, as the Fed is fully aware that should this final bubble pop, there will be no coming back.