Why An Outsized LTRO Will Actually Be Bad For European Banks
By Tyler Durden
Published on ZeroHedge ( http://www.zerohedge.com)
Created 01/31/2012 - 13:25
 [1]
Submitted by Tyler Durden [1] on 01/31/2012 13:25 -0500
Bond [2] Capital Markets [3] Creditors [4] European Central Bank [5] Greece [6] Ireland [7] Nomura [8] Portugal [9] ratings [10] Sovereigns [11] Volatility [12]
The post-hoc (correlation implies causation) reasons for why the initial LTRO spurred bond buying are many-fold but as Nomura points out in a recent note (confirming our thoughts from last week [13]) investors (especially bank stock and bondholders) should be very nervous at the size of the next LTRO. Whether it was anticipation of carry trades becoming self-reinforcing, bank liquidity shock buffering, or pre-funding private debt market needs, financials and sovereigns have rallied handsomely, squeezing new liquidity realities into a still-insolvent (and no-growth / austerity-driven) region. Concerns about the durability of the rally are already appearing as Greek PSI shocks, Portugal contagion, mark-to-market risks impacting repo and margin call event risk, increased dispersion among European (core and peripheral) curves, and the dramatic rise in ECB Deposits (or negative carry and entirely unproductive liquidity use) show all is not Utopian. However, the largest concern, specifically for bondholders of the now sacrosanct European financials, is if LTRO 2.0 sees heavy demand (EUR200-300bn expected, EUR500bn would be an approximate trigger for 'outsize' concerns) since, as we pointed out previously, this ECB-provided liquidity is effectively senior to all other unsecured claims on the banks' balance sheets and so implicitly subordinates all existing unsecured senior and subordinated debt holders dramatically (and could potentially reduce any future willingness of private investors to take up demand from capital markets issuance - another unintended consequence). We have long suggested that with the stigma gone and markets remaining mostly closed, banks will see this as their all-in moment and grab any and every ounce of LTRO they can muster (which again will implicitly reduce all the collateral that was supporting the rest of their balance sheets even more). Perhaps the hope of ECB implicit QE in the trillions is not the medicine that so many money-printing-addicts will crave and a well-placed hedge (Senior-Sub decompression or 3s5s10s butterfly on financials) or simple underweight to the equity most exposed to the capital structure (and collateral constrained) impact of LTRO will prove fruitful.
 [14]
The spread between senior and subordinated financial risk has compressed off crisis wides but remains elevated at prior crisis peaks. While not cheap explicitly, it would be a most direct way to hedge an oversize LTRO's impact on bank's balance sheets and obviously is a quite contrarian play.
Notably, even with spreads rallying today, this spread started to leak back wider as perhaps smart traders are seeing this opportunity.
LTROs are increasingly punitive and lead to subordination of senior unsecured bank debt.
The haircut structure and increased asset usage effectively means that further ECB liquidity is increasingly punitive, utilising ever more balance sheet. The more the facility is used the greater the degree of subordination to senior creditors, which previously would have partially relied on the assets, now pledged to the ECB, as security against senior debt. This problem is particularly pertinent given that banks have already been using the covered bond markets to raise funds, which require over-collateralisation in order to achieve higher ratings and to meet the criteria laid down by the ECB in order to be deemed eligible collateral for operations.
Nomura: How big will the next LTRO be?
The next 36-month operation is likely to be big; the question is how big? It should be bigger than the shorter LTROs as the long-term operations have a major advantage with regards to the timing of the payment of interest on borrowings. Besides the haircut taken on the collateral, the interest cost, from a cash perspective, is only settled at the end of the term of the repo meaning a reduction in interim funding cash flows. This is a major advantage over the 1w/1m/3m funding roll to cash-strapped banks.
Upside reasons to consider:
- The inclusion of a broader spectrum of loans should lead to a significant amount of additional balance sheet available for repo through the ECB operations. The downside to this is the significant haircuts on these assets.
- With the reduction in credit criteria on loans eligible. There is perhaps potential for funds drawn through the ELAs in Greece and Ireland to transfer to the mainstream ECB LTROs.
- Deposit levels in peripheral countries, and the degree to which they have been fluctuating, may be instructive as to the amount of funding that may be taken down. The higher the volatility of these deposits the more attractive the ECB insurance option should be.
Factors that could weigh on the overall size of the next operation:
- Banks have taken a significant amount of ECB funding already, with a marked increase from Spanish and Italian banks. According to national central bank data, an incremental €26bn and €57bn was taken by banks domiciled in those countries respectively. The Spanish take at the end of December 2011 was €132bn against the €210bn borrowed by Italian banks. We think the funding taken will cover 2012 bank redemptions to a significant degree.
- Decreased volume of liquidity rolling from old LTROs and MROs :-> For the December operation €50bn rolled for the October 12-month operation as well as from the 3-month.
- The ECB dropping its reserve ratio from 2% to 1% means liberation of funds, though this should largely affect MROs on the margin, but funds that were not provided through liquidity operations will now be available to banks increasing available liquidity.
- Bigger picture, the level of deleveraging in the banking sector as well as the private sector could lead to reduced funding requirements.
In aggregate we think that the total level of funds taken down through the ECB operation will be less than the previous round. In our estimation this is likely to be in the €200-300bn range.
If the size is bigger than this, perhaps in the range of €500bn or greater, the effect on bank balance sheets in Europe will be distinctly negative in our view, and would make future wholesale and term funding from private sector sources significantly more difficult.
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Greece Releases New Proposal With Even Greater Losses To Creditors
By Tyler Durden
Published on ZeroHedge ( http://www.zerohedge.com)
Created 01/31/2012 - 13:57
[1]
Submitted by Tyler Durden [1] on 01/31/2012 13:57 -0500
Bond [2] Creditors [3] Deutsche Bank [4] Fresh Start [5] Greece [6] recovery [7] Reuters [8] SocGen [9] Sovereign Debt [10]
The most recent addition to the "I am Jack's complete lack of surprise" pile comes from Reuters, which reports that the latest out of Greece is a proposal for even greater cuts for creditors than previously expected. From Reuters [11]: "Greece's private sector creditors could take a loss of more than 70 percent in a planned debt swap, Finance Minister Evangelos Venizelos said on Tuesday. "There is a very serious discussion based on new facts. We are talking about a PSI much greater than the original," he told lawmakers, referring to private sector involvement in the deal. "We are talking about a haircut on the net present value exceeding 70 percent," he said."
What this means, simply, is that when calculating the NPV of the post-reorg bond, the Yield to Maturity is now less than 30%, and thus is likely going to have a cash coupon of about 3.6%. This is relevant because as is known, one component of the creditor recovery is receipt of EFSF bill in lieu of cash to the tune of 15 cents of notional, and the balance, at least until this point, would have been a 35% yielding piece of post-reorg paper (for a 50 cent total cut as agreed upon in the October bailout). That was the case when the cash coupon was 4%. Going forward, and assuming a 3.6% cash coupon, the return on this fresh start debt drops substantially. Needless to say, creditors will almost certainly balk at this, because when it comes to calculating real yield, most are expecting a roughly 90% recovery at best on the EFSF strip (as every fund will scramble to dump their paper), so 14 cents on the total, and then funds are also hoping for at least 1 year of current yield, i.e., cash coupon. It becomes iffy around the 2 year mark, as it is a roughly 90% probability that Greece will file for bankruptcy yet again just after the first coupon is paid, at least according to hedge fund return calculations. It also means that nobody gives a rats ass about the IRR (as nobody expect to get post-reorg bond principal at maturity), and all are solely concerned with what the cash coupon will be that they can collect for one, max two years.
Which explains why at 14 cents + 3.6 + 3.6 or 21.2, which is where Greek paper trades currently, there is absolutely no upside for creditors, and the only real upside option is to hold out for sovereign debt litigation, where the recovery could be as high as par. Expect no deal to come out of this, despite what the IFF, which now likely represents just Deutsche Bank and SocGen, says. So much for that upper hand.
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MF Global Customer Funds Were Not "Vaporized" - Stanley Haar Takes WSJ to Task
By EB
Published on ZeroHedge ( http://www.zerohedge.com)
Created 01/31/2012 - 14:42
 [1]
Submitted by EB [1] on 01/31/2012 14:42 -0500
Commodity Futures Trading Commission [2] Creditors [3] Fail [4] George Soros [5] Goldman Sachs [6] goldman sachs [7] MF Global [8] Newspaper [9]
by Stanley Haar [10]
As a individual trader and CTA whose accounts are owed several million dollars by MFGI, I would like to express my shock and disappointment with [yesterday's] front page article; I expected better from the WSJ. Your article gives the appearance of having been ghost written by Andrew Levander and/or the JP Morgan legal department. Among the key errors/omissions:
• Client money in segregated bank accounts was not "vaporized"; it was stolen via illegal transfers to support MF's proprietary trading positions and to repay creditors such as JP Morgan. Those transfers are and always were illegal…….even "under rules at the time". Your use of that irrelevant and misleading phrase twice only serves to deflect attention from the criminal acts committed by Corzine, Abelow, Steenkamp and Ferber. Your own article goes on to state that "rules require customer funds to be set aside and kept safe". Even Gary Gensler and Jill Sommers have testified that customer funds needed to be segregated at all times. The failure to do so is a clear violation of the Commodity Exchange Act; "intent" is not an element of this criminal act.
• Although you correctly cite the difficulty in recovering the stolen funds, you fail to explain the main reason for this difficulty: the highly suspicious and irregular way in which the bankruptcies of MFGI and MFGH were implemented. Under a properly executed FCM bankruptcy process, customer segregated funds always have absolute priority over all other creditors. Instead, MFGI was placed under a SIPA liquidation, even though 98% of the accounts were commodity accounts not covered by SIPC protection. Compounding this bizarre step (apparently orchestrated by key general creditors such as JP Morgan and Goldman Sachs without resistance from the CFTC), the assets under the control of MFGH were not frozen and that entity was allowed to continue operating under Chapter 11 bankruptcy rules. This allowed unknown billions in assets to be dumped into the hands of George Soros, JP Morgan and various hedge funds at bargain prices (as reported by your newspaper), thereby locking in realized losses on those positions and moving assets out of the reach of the MFGI trustee.
• The bottom line is that customer funds were stolen twice: first by the illegal looting of segregated accounts by MF management, followed by the fraudulent way in which the bankruptcy was structured so as to circumvent the priority status of customers in the distribution of MF assets. This is the real story and scandal of MF Global, and perhaps one day your paper will decide to cover it.
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