Bankers cheer game changer of ECB Christmas cash

Fri Jan 27, 2012 8:11am EST

* ECB cheap funds seen as "game changer" for EU banks

* Buys time for banks, cuts borrowing costs

* Another 500 bln euros or more could be taken in Feb

* But doesn't solve problems, adds to ECB dependence

By Steve Slater and Alex Chambers

LONDON, Jan 27 (Reuters/IFR) - Half a trillion euros from the European Central Bank, the Christmas gift to banks that will keep on giving, has cut government borrowing costs, reopened funding markets and been the toast of Davos and City of London bars.

Urged on by top Italian and French bankers, the ECB provided a flood of ultra-cheap, long-term cash just four days before Christmas, with more to come at the end of February, and while some say it just papered over deep cracks in the European financial edifice, it has put a spring in the market's step.

"It is a game changer; it's taken away the risk of funding for the banks and given the market some confidence," said a senior banker at a European bank.

"Maybe it's just taken us away from the abyss, but it has given the market some time to fix things."

As many as 523 banks gobbled up 489 billion euros ($643 billion) of the ECB's unprecedented three-year liquidity lifeline, and even more could be taken at the February offer, potentially fulfilling their funding needs for all of 2012.

As intended, banks spent much of the cash on government debt -- maybe around 100 billion euros. Italy's 10-year bond yield has fallen below 6 percent for the first time in six weeks, and borrowing costs for Spain and across the euro zone have also fallen, shrugging off economic doubts.

It has made for a lively start to the year for bank fundraising, with a further 59 billion euros raised from covered bonds and unsecured debt.

Although that is down almost a third from the frenzy of activity seen early last year, it makes January already the best month for covered bonds since May and for unsecured deals since at least March, according to Thomson Reuters data.

It has been led by stronger banks such as Barclays, UBS, ABN Amro and Nordic names, and the market has stayed largely shut to peripheral eurozone banks, but that shows the need for the ECB backstop, bankers said. The banks' borrowing costs have fallen sharply, too.

Europe's bank shares index is up 14 percent since the ECB's three-year offer, with most of the surge coming last week, when bankers started lifting expectations for the scale of demand next month.

TRILLION EURO BAZOOKA?

The ECB was urged to act by desperate executives from UniCredit, Societe Generale and elsewhere after wholesale markets slammed shut for all but a few banks in the second half of last year. Politicians and regulators, too, wanted action to avoid a credit crunch for the "real economy".

At this week's annual World Economic Forum gathering in Davos, the plan -- officially the long-term refinancing operation (LTRO) -- was lauded. SocGen CEO Frederic Oudea said it had averted a credit crunch, and Canadian central bank chief Mark Carney said it had averted a Lehman-style crisis.

The Feb. 29 offer will allow banks to use more collateral and could attract demand for at least as much as December, and there was talk demand could be as high as 750 billion or 1 trillion euros, several bankers said.

Italian and Spanish banks were the biggest takers in the first offer, and the same is likely next month.

Banks will be keen to fill their 2012 funding needs while the window is open, wary that markets could later freeze up or be expensive to tap. Banks have 725 billion euros of debt maturing this year, including a record 282 billion euros in the first quarter, according to Thomson Reuters data.

The positive reaction to the first offer has removed fears that taking cash would be a stigma and be interpreted as a health warning by investors.

"Participating in the LTRO wasn't negatively perceived. There was no stigma attached," said Robert Gardiner, a director on HSBC's bond syndicate desk for financial institutions.

That could encourage the likes of Deutsche Bank, Nordic banks and UK banks with European units to join in after appearing to take modest amounts in December.

There may also be more use of a "carry trade", whereby banks borrow cheaply from the ECB at 1 percent to buy government bonds yielding far more to make a quick profit.

Small and mid-sized Spanish and Italian banks are most likely to be tempted to buy domestic bonds, and Italy's banks could boost profits by 20-40 percent by the trade, Citigroup analysts reckon.

But big banks are not expected to aggressively pursue the carry trade, with the likes of BNP Paribas unlikely to reverse their recent reduction in overseas sovereign bonds.

PAPERING OVER THE CRACKS?

The LTRO has bought time, but it does little to fix the banking sector's underlying problems, extends lenders' reliance on central bank help and has rewarded the less prudent banks.

"The problem is not solved, because there is no plan for growth or change, but (we are) safe in the knowledge that no banks will go bust; there's no Lehman moment coming any time soon," said Neil Dwane, chief investment officer for equities at RCM, a unit of Allianz Global Investors.

Recapitalisation demands, economic recession, the risk of euro zone collapse or disorderly Greek default and years of deleveraging are forcing banks to reshape and investors to look hard at the returns on offer.

The LTRO has been characterised by some as quantitative easing by the back-door, something euro zone paymaster Germany is staunchly opposed to.

"It's basically QE in disguise, with an automatic reversal in three years' time," said Padhraic Garvey, global head of developed debt and rates strategy at ING Bank.

And while providing ultra-cheap funds to troubled banks, more conservative banks have been less impressed.

"It had unfair implications. Suddenly every European bank got very cheap funding -- regardless of what job they did before," said a treasurer at a German bank. "The ECB was right to offer longer-term liquidity, but it's too cheap," he said.