It’s bazooka time: 489 bn EUR draw dawn on 3 year ECB facility, second bazooka still in store

8 days ago, I commented on the ECB announcement which in my opinion was totally misinterpreted by the market:

My summary was as follows:

Summary: In my opinion, the market severely under estimates the potential impact of the announced measures. For many banks this will be the lifeline to survive the next few years and potentially even Governements could gain a „back door access“ to the ECB. I am not saying that banks are a „buy“ right now, but this should take a lot of stress outof the EUR banking system.

So let’s look at what happened today, as reported by Bloomberg:

The Frankfurt-based ECB awarded 489 billion euros ($645 billion) in 1,134-day loans, more than economists’ median estimate of 293 billion euros in a Bloomberg News survey. The ECB said 523 banks asked for the funds, which will be lent at the average of its benchmark rate — currently 1 percent — over the period of the loans. The ECB also lent banks $33 billion for 14 days in a regular dollar offering, up from $5.1 billion a week ago. The euro jumped half a cent to $1.3198.

So banks did the rational thing and took the 3 year 1% line up to the maximum level. From my point of view there are a couple of second order effects which have to be considered:

1. If one estimates the “undisturbed” 3 year financing cost of the banking system at ~4% p.a., this line indirectly creates 500*3%= 15 bn equity p.a. for the European banking sector or even more if Draghhi further lowers rates

2. there is still the second bazooka in the store, as the exact same facility will be offered again in February next year, again on an unlimited basis

It is also interesting to read some comments like this form the “clever” analysts which I take a proxy for the overall market:

Crucially, this build up in expectations points to asymmetric risk regarding this morning’s LTRO. For an upside surprise, one would arguably need to see take up materially above the EUR300bn mark (say EUR350bn-plus) while, given the positive skew of forecasts, anything sub-300bn, could potentially prove disappointing. Under the former scenario, one would expect a further rally in short-dated peripheral paper, a firmer euro on the back of hopes this back-door peripheral support package will work and a sell-off in core paper on the back of the resultant risk on move.

In the absence of a monumental number, however (say, EUR400bn plus), these moves will likely be muted given how much positive LTRO-related news is already priced in (Italian and Spanish 2y yields having rallied 111bp and 69bp respectively in the last week).

If we translate this in plain English:
– “the market” did not realize 10 days ago that the facility was a big thing
– then for some reasons spreads narrowed
– now “the market”, which didn’t realize the impact in the first instance of course has now an educated opinion of what the amnount should be

So going back from that “rant” about so called experts and “market expectations”, what are the facts:

A) banks will be adequately (liquidity) financed going forward, we don’t have to be afraid of a liquidity induced crisis at an European bank for the next 1-3 years

B) additionally, some Solvency capital can be built up through this measure, however not enough to avoid some recapitalizations

C) bank and governments can now concentrate on Solvency instead of worrying about liquidity (remember: Lehman and Bear Stearns went down because of a Liquidity crisis!!!, Ireland got into trouble because they had to guarantee liquidity to their banks)

D) the impact on Government spreads is unclear in my opinion, this depends on what banks are doing

E) the impact on business and real estate should be positive, as refinancing should become more easy and cheaper.

F) However a risk of “crowding out” from Government debt could develop if banks decide to invest primarily in higher yielding government securities

As said before, this is not the final solution of the EUR crisis but one of the many steps reuqired to do so.

Personally I like the less dogmatic approach of the ECB under Draghi a lot. Sometimes it might be better to have a pragmatic Italian to run the show than a dogmatic German.

From a investor point of view it will be even more important to focus on the facts, especially what the ECB, the polititians and supervisors are doing than what the market expects. Expectation can change any minute, actions persist and can create real changes.

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