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Fitch Ratings says, ahead of the European Central Bank's second Long-Term Refinancing Operation (LTRO), that the first played a crucial role in stabilising euro financial markets by allaying funding concerns that were bringing parts of Europe's banking system to the brink.
"December's Long-Term Refinancing Operation provided access to medium-term funding that had been drying up for an increasing number of European banks," said Bridget Gandy, Managing Director and co-head of EMEA Financial Institutions. "It has been operational in revitalising some degree of confidence in European bank bonds and bringing down sovereign bond spreads." These factors have prevented further and deeper bank downgrades. "In some cases," says Gandy, "time has been bought that will enable banks to work through their difficulties. But for other already low-rated banks, the Long-Term Refinancing Operation's life-support is merely stalling their demise."
The European Central Bank (ECB) will issue its second three-year LTRO on 29 February 2012. The 22 December LTRO was taken up by 523 European banks for a total of EUR489bn.
Although take-up of December's LTRO was widespread, the financial boost was particularly prevalent in Italy and Spain once netting of existing ECB facilities is taken into account. There was also strong additional take-up from German banks, although less uniform across the sector. Most banks in the Nordic region, the Netherlands and Switzerland did not participate.
Fitch does not envisage much use of the carry trade with sovereign bonds, given that European banks are exiting cross-border sovereign exposures where they can. Fitch considers that medium-sized Italian and Spanish banks or cajas would be the most likely users of the carry trade, given the spread on domestic sovereign bonds over the 1% LTRO borrowing rate, absent any impairment costs. Sovereign bond spreads showed a marked improvement following the LTRO and consequent momentum for a more liquid market in these bonds.
Fitch thinks it unlikely that the LTROs will drive strong lending growth, given the lack of any notable demand. However, thwarted hopes that this would occur need to be balanced by the prevention of more rapid deleveraging that would otherwise have happened. Use to date has been predominantly to replace existing forms of funding and stem deleveraging that limited access to replacement funding would have necessitated.
Fitch is not making any projection of take-up of the second LTRO. However, the agency notes that mid-sized banks, in particular in Italy and Spain, have been preparing collateral in anticipation. Furthermore, given that there seems to have been little stigma attached to the first round, Fitch expects greater take-up this time by relatively strong banks, given that the LTRO is a cheap source of three year funds.
For more information, see 'European Banks' Usage of LTRO: A Stabilising Influence', which is available at www.fitchratings.com.
