| Government bonds crowding out lending? |
| 30.01.12 12:02 | |
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We have been arguing that the 3y LTRO conducted by the ECB would support government bonds only temporarily. We argued that collateral-constrained banks would borrow against government bonds, hoping for an easing of the collateral-eligibility criteria before their redemptions became due. Banks that were able to generate collateral from their existing balance sheet or via government guarantee schemes, on the other hand, would find it attractive to park their excess cash in government bonds in preparation for redemptions. The latest credit numbers from the Eurozone, we would argue, corroborate this interpretation. December saw the largest contraction in the provision of credit to non-financial corporates in the history of the time series. Lending to households also contracted. On a 3M MA basis, the flow of credit relative to GDP is now contracting considerably faster than in the midst of the post-Lehman phase. Interpreting this data correctly in the context of the ECB’s 3y LTRO is difficult, but we believe we can draw a few conclusions: - The announcement of the 3y LTRO did not change banks’ willingness or ability to lend to non-financial corporates or households. In other words, the 3y LTRO announcement benefited short-dated government bond markets, but not the real economy. - If the announcement effect was not significant, this suggests that banks remained constrained in their ability to fund loans on an unsecured basis, which suggests that: (1) the collateral changes yet to be announced by the ECB will be critical, and (2) in the absence of a change in the collateraleligibility criteria, January is likely to show a similar picture. - As and when the collateral eligibility criteria are changed to allow for an easier posting of loan books to the ECB, we believe that we could see some reversal of these developments, including waning support for peripheral government bond markets. This also suggests that the true measure of success for the LTRO will be whether credit to the real economy rebounds in the coming months. Looking at the extent to which different banking systems have made use of the LTRO, Italy, Spain and France stand out as users of the ECB’s liquidity facilities. Interestingly, Portuguese banks were not big takers. Not surprisingly, we therefore see a significant outperformance for example of Italian and Spanish paper, in particular at the front-end of the curve. The fact that Portuguese banks did not make use of the LTRO, in our view, confirms the fact that banks can be limited in their ability to borrow against government bonds, given the capital charge risk banks now face via the EBA stress tests. We see the correlation between the ECB usage statistics and performance, as well as the deep deleveraging statistics from December as confirming our view that the lack of collateral eligibility clarification prior to the last 3y tender was a driving factor behind skewing banks towards government bonds. We therefore believe that, if and when, the ECB announces the collateral changes, support for peripheral government bonds could wane as banks substitute loan books for government bonds. Our more cautious assessment is also backed up by the latest deposit dynamics. Encouragingly, Greek deposit outflows did not accelerate in December. Disappointingly, however, Portuguese and Spanish deposit dynamics did deteriorate, in line with the deterioration in the macro outlook. With the Greek situation still unresolved (an agreement on PSI terms does not automatically imply an agreement on the PSI), deposit dynamics remain a threat to banks’ balance sheets and therefore to sovereigns. While timing the potential reversal of peripheral spread tightening is difficult given the uncertainties highlighted above, the impact on the short-end remains clear cut in our view: we are bullish the short-end, particularly with the announcement of the ECB-eligibility criteria for bank loans and another 3y LTRO (on 29 Feb) still to come. Levels become attractive again following last week's moderate sell-off caused by the softening pace of decline in Euribor fixings. However, in order to minimize the short-term effect of the fixing, it is best to move further down the curve. At current levels, we like to buy Sep12 or Dec12 Euribor futures outright (trading at 99.17, target 99.30; stop-loss 99.12). source: BofA ML |
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