As expected, virtually everyone, or a total of 39 banks (compared to 2 the week prior), scrambled to receive dollars from the ECB following the cut in the USD swap line rate from OIS + 100 to OIS + 50. Specifically, $50.7 billion in 84 day swaps (34 banks asking for dollars at a new and reduced rate of 0.59%) and $1.6 billion in 7 day swaps (5 banks at 0.58%) was just opened for a total of $52.3 billion. The expectation had been that just about $10 billion would be demanded, indicating how close to the cliff Europe's banks had been. This compares to just over $2 billion in the week before, and demonstrates the severity in the funding market that threatened to topple European banks like dominos last week until precisely a week ago the global central bank cartel announced an emergency dollar funding band aid. Reuters confirms: "Banks took more than $50 billion from the European Central Bank on Wednesday in its first offering since slashing the cost of borrowing dollars, a sign that some euro zone banks have problems finding dollar funding as the region's debt crisis intensifies." Elsewhere dollar libor continued to rise, passing 0.54% for the first time in years. This will continue rising as the self-reported dollar funding cost closes down to the OIS+50 differential, or where European banks can borrow from the Fed. And now that the dollar funding squeeze has been confirmed, all eyes turn to the ECB's LTRO announcement tomorrow. "What really matters is what the ECB does tomorrow afternoon, and in that especially what they do with the long-term refinancing operations (LTROs) and on the collateral rules," Societe General economist Michala Marcussen said. "What would be extremely helpful right now is if we get longer maturity LTROs." The ECB is expected to announce ultra-long 2-year or even 3-year refinancing operations after its meeting on Thursday." Needless to say, all these are stopgap liquidity measure to fix what is increasingly a pan European (in)solvency crisis, and thus will achieve nothing in the long run. And what is worse is that the non-USD liquidity indicators have once again hit an inflection point and turned negative: 3-mo Euribor/OIS spread rose to 1.002 vs 0.999 yesterday, near last wk’s high of 1.006 which was most stressed since March 2009. In other words, as we have been saying, the funding squeeze has now managed to shift away from USDs and is impacting the EUR market itself, something the Fed has no control over.
Goldman's Jernej Omahan has more.
In total, 34 banks (previously two banks) tapped the facility for US$52.2 bn (previously US$2.1 bn). In our view, this is an encouraging development. [this is Goldman after all telling us central bank bail outs are good, so nothing new]
The cost of US$ liquidity offered to European banks through the ECB has recently (November 30) been reduced – the rate was cut to OIS+50 bp (previously OIS+100 bp) and the initial margin requirement to 12% (previously 20%). In our view, the current US$ facility provided through the central banks is more attractive when benchmarked against two major marketbased alternatives. As such, we anticipated this rise in usage.
We expect the key results of increased usage to be:
- Some easing of extreme funding tensions. These have continued to build over recent weeks (rating downgrades, proximity of
year-end) and US$ funding stress indicators reached a two-year high.
- Eliminating the stigma. The market viewed the US$ facility as an emergency option and usage came with substantial stigma.
- Consequently, the banks avoided it. The number of participating banks rose from two to 34. Broad usage is important as it reduces the stigma and is unlikely to result in a “hunt” for banks accessing the facility. Given renewed terms, it is commercially sensible for the usage to have risen, in our view.
Mechanics of the US$ funding facility with the ECB
The size of ECB’s US$ facility is unlimited and the price is capped at OIS+50 bp (with a 12% margin). The market for US$ unsecured
bond issuance has remained shut for European banks for a considerable period of time. The banks therefore have three basic
avenues to access US$: (1) via central bank facilities; (2) market US$/€ swaps; and (3) through a combination of the two. We lay out
our estimate of pricing for the three different facilities below:
- ECB facility = 1.08%, inclusive of the margin. This cost consists of US$ OIS (currently: 9 bp) and a mark-up added by the central bank (currently: 50 bp). The cost of 12% initial margin (IM) needs to be added – we estimate this to be around 49 bp currently (though this has the scope to vary among individual banks). All-in cost, therefore, is around 108 bp.
- Market rates for € funding and cross-currency swap = 1.71%. An alternative to the above is to access € funding through € LIBOR and obtain US$ through a cross-currency basis swap. The all-in cost here is 1.71% at current market rates. In line with risk perception, this source of US$ has been rising in price, and currently stands meaningfully above the cost of the ECB US$ facility.
- ECB repo for € funding and market rate for cross-currency swap = 1.48%. An alternative to the above is for banks to access € funding via the ECB repo rate of 1.25%, and use the market for the US$ cross-currency basis swap. Currently, this amounts to 1.48%, lower than the second option but still above the cost of ECB’s US$ facility.