Credit Suisse believes LTRO 2.0 will see a gross uptake of EUR500-650bn, notably above current consensus around EUR325bn. The math is straightforward and does not exaggerate too much for the speculative demand which they (like UBS) do not expect to be as significant as many happy-talkers. Between existing LTROs rolling off, rotation from the MRO, Emergency Liquidity Assistance financing, deposit flight, and reserve requirement reduction they arrive at around EUR300bn and believe a further EUR200-350bn in covering private debt refinancings (and perhaps some speculative activity though as we already noted the economics are nothing like as attractive anymore), their estimate is around twice the initial LTRO net increase which could take the ECB balance sheet to over 35% of GDP, dramatically above the US and UK, and the following scenario analysis sets out the short- and long-term implications of varying gross uptakes for LTRO 2.0.
LTRO 2.0 Gross Uptake and Implications
Based on data from the ECB we can estimate how much maturing debt is likely to be rolled into the February LTRO:
- There is a 28-day operation maturing on 15 February that amounts to €38.7bn;
- In an old 91-day operation held on 26 January, €25bn less was rolled than expected – we expect this to be put to work at the next 3y LTRO;
- MRO usage is expected to fall as it did following the first 1Y LTRO in 2009 (see Exhibit 8) – the minimum MRO usage was €50bn in November 2009. Current MRO usage is €130bn – so there is potentially €80bn that can be migrated into the 3y LTRO;
- Emergency Liquidity Assistance (ELA) financing – our economists estimate usage by Irish, Belgian and Greek banks via ELAs to be around €110bn; a large proportion of this can be moved to the LTRO;
- Deposit flight from peripheral European banks amounted to €120bn in 2011 – we expect a large component of this drop in deposits to be financed via the ECB;
- The reduction in the reserve requirement is expected to have released €103bn back to banks, reducing financing need.
So we expect about €150bn in old operations rolling into the new 3y LTRO. Then, any excess borrowing will depend on the range of additional credit claims that are made available and the need to replace lost deposits.
According to the ECB Financial Stability Review, Euro Area banks face about €550bn in maturing debt for 2012. If we assume that the €193bn net increase in liquidity in the December LTRO was used primarily for financing 2012 redemptions, it is possible that banks borrow a further €350bn in new cash at the next operation.
Taking the above factors together, we calculate that gross borrowing at the next LTRO could amount to €650bn (150bn old roll offs + 350bn refinancing need + x(120bn) lost deposits + y(110bn) ELA – 100bn reserve reduction). This estimate does not account for any speculative demand; given current yield levels and the likely evolution of the situation in Greece, we expect such demand to exist, but not to be a driving factor. This also does not account for collateral switching between the December and February LTROs – whereby banks took up extra funding in December in the hope that they could finance less liquid credit claims in February. Such collateral switching could serve to decrease our estimate.
The gross uptake on 29 February needs to be adjusted by about €150bn in rolling operations to calculate the net increase in liquidity to the Eurosystem. Our expectation of between €500bn and €650bn would therefore equate to €350bn-€500bn on a net basis, around twice the December €193bn net increase. It is also possible the ECB keeps the door open to further 3y LTROs if the situation warrants it and also as a mechanism to smooth out the redemption profile for LTRO operations.
ECB balance sheet to rise to 35% of GDP
As we have discussed on numerous occasions the ECB balance sheet as a percentage of GDP has already significantly surpassed the Fed and the BoE. Exhibit 6 shows the evolution of the ECB balance sheet (% GDP) versus the Fed and the BoE.
A €350bn net increase in liquidity is expected to increase total assets by the same amount, ceteris paribus. Given the wide range of expectations by the market, we include two estimates for the extent of increase in the ECB’s balance sheet: a net uptake of €350bn or €850bn. This, by our calculation, would coincide with gross uptake of €500bn or €1 trillion, respectively.
And as we have discussed many times recently, this will likely force the Fed's hand as the implicit USD strength would be too much to bear (given their explicit 2% per year devaluation mandate) - though the coincident timing of the Greek bond deadlines and LTRO 2.0 provides yet another wrinkle.