Sunday, April 15, 2012

Coming up with €163bn to keep the Spanish banking system afloat

On Friday the Spanish sovereign CDS widened to a record and further risk aversion spread throughout global markets. Equity markets closed sharply lower. One of the factors that contributed to the market jitters was a massive increase in LTRO financing for Spanish banks last month - a total increase of €163bn, more than doubling the amount outstanding in February.

LTRO amount for Spanish Banks (€ million)

However this should not have been a surprise, given the ECB's €433bn LTRO program net increase (from €664bn in February to €1,097bn in March). Where did people think this money was going? Spanish and Italian banks grabbed a large share of this financing. But confusion still persists about the mechanics of how Spanish banks actually borrowed the money.

The ECB provides this financing via Banco de España, the Spanish central bank, which is part of the Eurosystem. The table below shows the changes in Banco de España's balance sheet.

Banco de España balance sheet changes (click to enlarge)

This table tells us exactly how Banco de España came up with the €163bn:

Financing  €163bn of LTRO for Spanish banks

A big portion was financed via the Banco de España's contribution to the ECB Deposit Facility (green - above). Spanish banks immediately deposited a portion of the LTRO funds back with the central bank in order to use the funds later to pay off their maturing unsecured bonds (it would have been a disaster without the LTRO). Some was financed via the reduction in the MRO, the short term central bank funding (blue).

A portion was financed via the deposits from the Spanish government (purple). In the first quarter, the Spanish government had issued almost half of its 2012 borrowing needs - clearly more than it needs immediately. It had to do it while the markets were opened. Some of that extra cash got deposited with Banco de España to be used later (particularly in case Spain has problems auctioning new debt later this year, which is a real possibility). Other than a relatively small change in bank reserves and "fine-tuning reserve operations", the rest came by borrowing from the Eurosystem (orange) via TARGET2 (which went up sharply as expected.)

TARGET2 balances of  Banco de España (used to fund part of the LTRO for Spanish banks; € million)

That's what it took to keep the Spanish banking system afloat - for now. But was it enough? These banks will need all the help they can get as Moody's prepares for bank downgrades shortly.
WSJ: Concerns over Spain were exacerbated by a calendar published by Moody's Investors Service for the conclusion of its review of European banks. Traders are seeing the review-for-downgrades as a major potential negative catalyst for financials. The expected timetable kicks off with the review of Italian banks next week and Spanish banks the week commencing April 23.
Much of the government debt that Spanish banks bought with LTRO money ("encouraged" by their governments) is now under water as yields shot up. The banks are taking significant mark to market losses. With questions persisting about whether the ECB will resume supporting periphery bond prices (with Spain all but begging them to do so), the markets are in for more volatility.
WSJ: Remarks by ECB governing council member Klaas Knot soured sentiment further, dashing hopes for further bond buying of 'peripheral' debt by the central bank. Knot said the ECB hopes to never "use the bond-buying program anymore," and the positive impact of the ECB's longer-term refinancing operations or LTRO on banks and credit supply are still visible.

Update: Kostas Kalevras did a nice write-up on this topic.

Update: Spanish banks now trade materially below the November lows:

MSCI Spain Financials Index (Bloomberg)
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