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Talk it up

17 December 2014
Richard Kemmish

You can tell it’s bonus season. The consensual DCM narrative now is as follows: TLTRO was a failure and is outweighed by the repayment by banks of other ECB facilities. Therefore, Mario’s ambitions to expand the ECB’s balance sheet is thwarted. Therefore sovereign QE is inevitable restoring the value of covered bonds relative to sovereign debt.

Meanwhile, back on bank balance sheets the reason for the failure of TLTRO was that banks need to sell longer term debt to better meet their NSFR rules and banks need to buy covered bonds (now cheap relative to the alternative remember) to meet their liquidity cover ratio.

Therefore the doom and gloom predictions of lower covered bond issuance for next year are wrong. Therefore you need to pay your covered bond specialists more money.

I agree. If you are the boss of a DCM banker, please stop reading now.

Still with me? OK, so time to hold some of those assumptions up to the light.
Its true that LTRO take up was pathetic but what was the reason for this? Was it possibly that the terms of the facility make it attractive (longer term funding) if you are going to expand your lending to the real economy and kind of suck (repay in two years), if you are expecting balance sheet shrinkage, particularly in your SME loan book.

I so wish that a lack of cheap funding in the banking system was the problem for SME lending. But it clearly isn’t. Its all about capital – the only thing bank treasurers seem to worry about nowadays <sigh> and a lack of demand from the small enterprises themselves.

Then there is the uneven take-up of the facility. Let me hazard a guess that the take up (net of repayment of other ECB term funding) was positive for the bank’s with constrained access to funding, negative for those with excess liquidity. So that’s less funding needs from issuers who might have had to issue covered bonds, and no increase from those who weren’t planning to issue anyway.
Then you can question the ECB’s response and the prospect of sovereign QE. Have you noticed that the opinions on the inevitability of QE is almost directly correlated to the speaker’s nationality? For these purposes (only), consider me German. I’m sure that a lot of creativity is going to go into finding things other than (peripheral) sovereign bonds to expand the ECB’s balance sheet, whether real assets, corporate debt or ‘whatever you can find’ (a mirror of Mario’s ‘whatever it takes’).

Finally, might it just be Brussel’s fault that Frankfurt is frustrated? The requirement that banks hold more bail-inable debt (TLAC, MREL or whatever CFLA* it is nowadays) although not defined properly yet have led to some hasty rewriting of funding plans. The bad news is that this is going to have to be term debt and its going to have to be unsecured.

Sorry, but the current talking up the covered bond business could be just that, talk.
(* Contrived Four Letter Acronym)

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