Cash-starved Irish, Portuguese and Greek lenders have turned to punitive private borrowing facilities over recent months after maxing-out on official European Central Bank help, in an indication that some €400bn of emergency funding is no longer enough to keep the European banking system above water.
Investment banks are privately lending tens of billions of euros to eurozone banks through repurchase deals after some lenders were left unable to tap the central bank for more money. Emptied of securities eligible to be repoed with the ECB, such as government bonds, and desperate for cash, they have become dependent on private repo markets willing to lend against riskier assets – albeit at much higher interest rates.
The trend paints a much bleaker picture of the European banking system than official ECB figures indicate. While its open market operations have more than halved since last June to its current €415bn, implying improving health, for a handful of firms the emergency funding is no longer enough to pay the bills.
According to some estimates, the short-term funding needs of such banks – cash needed to fill ATMs, pay interest to bondholders, compensate staff, etc – could be closer to €800bn. Unable to issue bonds or revert to the interbank market, the ECB and repo markets are now their only option.
“Wholesale funding just isn’t available, and many banks are turning to the repo market for their short-term needs,” said James Nixon, co-chief European economist at Societe Generale. “There’s just no backstop for these banks, they’re effectively suffering from a drought of available cash. They came into the crisis with a big funding mismatch between long-term assets and short-term liabilities.”
Traditionally, banks would finance their needs through bond issues – an avenue which remains closed for many. Just one Portuguese firm has tapped markets this year, for example, while Irish and Greek banks haven’t sold a single issue. By contrast, banks from those three countries collectively issued €35.6bn in senior unsecured bonds last year and €18.9bn back in 2009, according to Thomson Reuters data.
“We’re seeing a bifurcation of the European banking industry, with firms either being judged to be good or bad banks by the market,” added Nixon. “Spanish and Portuguese firms are finding it hard to access the capital markets, seeing deposits declining, whilst others can happily fund themselves.”
That’s why the repo deals have become so important for a handful of firms. Some dealers have lent up to €5bn each to eurozone banks, taking in a variety of residential mortgage, commercial mortgage and corporate loan assets as collateral.
Not all the banks using such facilities are suffering from liquidity problems, however. Bankers are keen to stress that many banks have been keen to bolster a repo market for certain securities in preparation for the eventual withdrawal of the ECB emergency facilities.
Still, those using such facilities are facing often punitive interest rates. Exact figures are difficult to come by, but bankers have quoted rates of between 4% and 7% – far higher than the 1% that the ECB charges for using its open market operations facility – and analysts fear that could worsen the finances of many lenders earning only low rates on their long-term assets.
“Many of these banks have an adequate capital base, what they really lack is liquidity,” said Ivan Zubo, a credit analyst for European banks at BNP Paribas. “But what starts as a liquidity problem can become a capital problem when the cost of funding and elevated provisioning starts eating into profitability and you’re forced to sell off assets at a deep discount.”
An additional problem for lenders is also the dependability of such credit facilities. Unlike the ECB, which at present funds all requests so long as the assets posted are of a minimum quality, the repo model is heavily dependent upon private banks’ willing to take risk. A ratings downgrade on any of the assets could prompt a sudden withdrawal of credit, leaving cash-strapped banks without funding.
“Non-central bank funding is available for some of the peripheral country banks, but the supply of liquidity from the markets is more volatile than that from the ECB,” said Matt Spick, European bank analyst at Deutsche Bank. “If the collateral that these banks may be using comes under pressure, by rating changes or haircuts, some banks could find themselves in trouble.”
That sentiment was echoed by Zubo: “The problem comes when these assets are downgraded – then you may need to put up even more collateral,” he added. “That doesn’t solve the situation; in fact it might aggravate it.”
Indeed, ratings downgrades have become all too common for many of the assets being used to back these repo transactions, as agencies grow increasingly worried about the ability of individuals and companies alike to keep servicing their debts. Only last week, Fitch Ratings placed 41 tranches of 38 Portuguese structured finance transactions on negative watch, while earlier this month Moody’s downgraded 50 tranches in 17 prime Irish retail mortgage-backed deals.
The issue is further complicated by the inability of these banks to sell down such assets as an alternative way to raise cash.
Following years of real estate binges, their balance sheets remain clogged with billions of euros worth of mortgage-backed securities. Secondary markets for MBS linked to European real estate have largely seized up since the crisis, denying banks the option of selling.
Even if they were to find buyers, banks would have to accept massive discounts, resulting in whopping losses – and further capital problems. According to Barclays Capital, Triple B rated Irish and Portuguese RMBS would have attracted bids of 39 cents on the euro earlier this week, while similar Spanish securities were trading at 46 cents.
“These banks have to reduce their balance sheets, they need to sell off a whole bunch of loans they still have on their books,” said one senior London-based. “The trouble is that, while some hedge funds are circling around these assets, they are very hesitant. They are struggling to understand.”
“Even if there was a buyer for some of these assets, the prices paid would be extremely punitive. Whilst there is still an emergency financing window open in the form of the ECB, it makes sense to take that line of escape. The alternative would be taking some huge writedowns.”
That severely complicates the issue for an ECB that is keen to withdraw emergency measures as soon as possible. Trichet and others are understood to be concerned that cheap loans could be distorting competition, effectively subsidising the vast majority of healthy eurozone lenders.
But with a handful of banks still teetering on the brink of becoming illiquid, the ECB may not be able to pull its emergency funding – introduced at a time of extreme market tensions – anytime soon.
“If you sent the ECB on holiday for a week, the whole European banking system would collapse,” said the senior banker, who spoke on condition of anonymity for fear of upsetting clients using the firm’s credit lines. “Right now it’s one of a very few entities holding the system together.”
“The ECB is unhappy with the situation and senior officials at the central bank are slowly coming to terms with the fact that they’re going to have to keep funding some of these banks for at least another three or four years,” said Nixon.
Gareth Gore