ECB's First TLTRO A "Failure": European Banks Take Less "Free" ECB Loans Than Worst Case Expectation

As part of Draghi's attempt to reflate the ECB's balance sheet by €1 trillion, a key variable was the extension of the LTRO (1&2) program, in the form of the Targeted LTRO, or TLTRO aka LTRO 3 & 4, whose initial take up results were announced earlier today. It was, in a world, a flop. Because while the consensus was for European banks to take anywhere between €100 and €300 billion in nearly zero-cost credit from the ECB (at 0.15%) to engage in carry trades in today's first round TLTRO operation (ahead of the second TLTRO in December), moments ago the ECB announced that banks, which head already been actively paying down the first two LTRO carry programs, of which only €385 billion had been left of over a €1 trillion total at inception, were allotted a tiny €82.6 billion across 255 counterparties.

From the ECB:

18 September 2014 - ECB allots €82.6 billion in first targeted longer-term refinancing operation

  •     Banks take up €82.6 billion in first of eight TLTROs
  •     Programme supports lending to the real economy
  •     Part of package of ECB measures that will have sizeable impact on ECB’s balance sheet

The European Central Bank has today allotted €82.6 billion to 255 counterparties in the first of eight targeted longer-term refinancing operations (TLTROs) to be conducted between September 2014 and June 2016. The programme is designed to enhance the functioning of the monetary policy transmission mechanism by supporting bank lending to the real economy.

 

In order to participate in the tender that was announced on 16 September, credit institutions had to express their interest and send completed reporting templates by 28 August. A total of 382 entities were eligible to bid in the first TLTRO, representing, either directly or indirectly, 1372 credit institutions. Additional counterparties that intend to participate in the second TLTRO in December will have to send completed reporting templates by 20 November 2014, 3.30 p.m. CET.

 

The second TLTRO, as previously communicated, will be announced on 9 December and allotted on 11 December.

 

In the first two tenders, banks and groups of banks are entitled to an initial borrowing allowance equal to 7% of the total amount of their loans to the euro area non-financial private sector, excluding loans to households for house purchase, outstanding on 30 April 2014. Therefore, eligible banks who have not reached their initial allowance limit in the first TLTRO will be able to increase their initial borrowing amount up to that limit in the second TLTRO.

 

Thereafter, banks will be able to apply for additional funding, depending on the evolution of their lending activities against a specific benchmark.

 

The TLTROs, first announced on 5 June, together with measures announced on 4 September related to the purchase of non-financial private sector assets, will have a sizeable impact on the ECB’s balance sheet.

This TLTRO was, in a word, a failure, if not unexpected. After all European banks had already paid down €700 billion from the first two LTROs when Draghi stunned everyone by announcing he would shove even more free "carry trading" paper down everyone's throats, even if there was significant implied stigma associated with taking up the ECB's LTRO, an admission of balance sheet weakness if you will. So it was not exactly unexpected that banks were leery of participating in the program, especially since they don't have to: after all very soon the ECB will use its own balance sheet for monetization purposes and bypass the bank intermediary pathway, where the ECB does QE by way of European bank proxy.

In fact, the less TLTRO taken up, the higher the push back to the ECB to do more private and public QE on its own!

Understandably the sell-side couldn't wait throw up all over it: here is what ING's analyst Martin van Vilet said: 

  • Allotment of EU82.6b in one word is disappointing, ING analyst Martin van Vliet says in e-mailed note.
  • Expects excess liquidity to rise to ~EU150b vs EU93b
  • Eonia to trade in -5bps to -10bps range
  • Takeup to raise doubts on feasibility of ECB plan to boost balance sheet by EU1t

But while the TLTRO was a failure, the sellside pundits were quick to spin it as good news because, you see, a week TLTRO take up simply means more heavy lifting left for the ECB's QE, meaning a failure here means more "success" for the ABS monetization (aka Private QE) program and subsequently, outright public QE. Case in point, Citi:

  • Any EUR move higher on limited TLTRO takeup is expected to fade as ECB would have to do more given that it can’t rely on banks to boost size of balance sheet, Valentin Marinov, European head of G-10 FX at Citigroup, says in e-mailed comments.
  • TLTRO takeup came at EU82.6b, below market expected range of EU100b to EU300b
  • EUR may squeeze higher at least initially as money market rates recover
  • ECB could be forced to buy substantial amounts of ABS/covered bonds when they meet on Oct. 3

And Rabobank:

  • Speculation that the ECB will conduct QE is expected to rise ’markedly’ as it becomes clearer that TLTRO will not be big enough to increase ECB balance sheet up to EU3t mark, Rabobank strategists say in emailed comments.
  • Latest comments out of Spain and Italy suggest low participation from these countries’ banks
  • Tomorrow’s 3-yr LTRO repayment to offer more clues on bank participation
  • Big gap between TLTRO 1 and 3-yr LTRO would suggest smaller participation from peripheral banks, which may instead look to replace 3-yr LTRO funding in December

Finally, Nordea:

  • Lower-than-est. takeup of EU82.6b shows ECB’s first targeted longer-term refinancing operation was a failure, Alexander Wojt, analyst at Nordea, says in interview.
  • Nordea expected EU140b vs median est. in Bloomberg survey of EU150b
  • Immediate short-end EUR market reaction is disappointment, as further liquidity had been priced in
  • Probably provides good entry point for short-dated Eonia longs and EUR/USD cross currency basis swap wideners
  • Operation puts pressure on ECB to do more; will be hard for central bank to achieve balance-sheet expansion plans even if covered bond- and ABS-buying programs are included
  • Low takeup was probably due to core banks refraining from bidding as there isn’t enough carry on offer and there’s stigma attached to taking ECB funds

Perhaps the best summary of today's flop comes from Goldman Sachs:

€82.6 bn of TLTRO funds were allocated today, in the first of two auctions, where theoretical take-up is capped at €400 bn (we refer to them as “LTRO-3”). Consensus expectation is for €267 bn to be allocated over both auctions:

 

The initial LTRO-3 auction therefore:

 

(1) amounts to 31% of consensus expectations for combined take-up in both auctions

(2) leaves €184 bn of take-up for LTRO-3 December auction, were consensus expectations to be met. This would represent a €102 bn (123%) increase on today’s auction

(3) is unlikely to leave the equity market excited, in our view.

 

Net injection a function of LTRO-1&2 put-back

 

Today’s LTRO-3 funds allocation represents a gross injection of liquidity. The “net” injection will be a function of LTRO-1&2 put-backs, which will be announced on Friday.

 

LTRO-3: Allocations vs. current usage

 

LTRO-3 is capped at €400 bn, with bank allocations proportionate to size of eligible loan books. Allocations do not map well with current LTRO-1&2 usage (€385 bn), which is heavily skewed at the country level (towards Italy and Spain) and within individual countries (mid-sized banks). We believe that select banks will look to fill the liquidity shortfall with MRO or market REPOs.

 

LTRO-4: The bigger chunk of TLTRO

 

We see LTRO-4 as a more potent liquidity tool and estimate take-up, spread over 2015 and 2016, in the €520-610 range.

 

 

Bottom line: The allocation of 4-year liquidity to Euro area banks under the ECB's first Targeted Long-term Refinancing Operation (T-LTRO) was €82.6bn. While there was no formal consensus expectation for this operation, it is towards the lower end of most estimates.

 

1. The ECB has conducted the first of its Targeted Long-term Refinancing Operations (T-LTRO) that were announced in June. As part of the operation it has allocated €82.6bn of 4-year funding at a fixed rate of 15bp. While there was no formal consensus expectation for the size of the operation, it is towards the lower end of most estimates. Our expectation has been for the combined take-up across this September T-LTRO and the December 11 operation to be around €250bn, with the take-up at the December operation expected to be larger than that at today's allocation. That banks are awaiting the results of the ECB/EBA stress tests may have contributed to a lower take-up at this operation. And the allocation at the December operation is necessary to assess today's outcome.

 

2. At his September 4 Press Conference, ECB President Draghi refocused attention on the size of the ECB's balance sheet (see here). Today's operation is one important input into how the size and composition of the ECB balance sheet evolves in coming months. Other key inputs are the repayments of 3-year LTRO funding (funding that will eventually expire by the end of February) as well as the asset purchase programme announced on September 4. Further details on the asset purchase programme are expected at the ECB's October 2 policy meeting.