LONDON, Dec 20 (IFR) - The extent to which European banks start repaying borrowed money from the European Central Bank will likely be a critical driver of primary markets in 2013, debt capital markets bankers said this week.
The unprecedented EUR1trn of liquidity the ECB pumped into European banks via two three-year Long Term Refinancing Operations in December 2011 and February 2012 dominated credit markets in 2012, averting a bank liquidity crisis but also impacting primary volumes.
According to JP Morgan, even as redemptions were sky-high at EUR343bn this year, unsecured issuance came in at a paltry EUR114bn up until mid-November. How banks get weaned off cheap central bank liquidity will be a big theme next year.
“LTRO repayment will be the most important factor in 2013 because banks continuing to delever means that there is limited natural growth for extra funding elsewhere. This, as well as banks switching from secured to more unsecured funding, will be the big drivers of activity,” said Edward Stevenson, head of FIG DCM at BNP Paribas.
David Marks, chairman of FIG DCM at JP Morgan agreed. “In the last quarter some banks have said they will view 2013 as the start of the refinancing project of ECB money,” he said.
“If we continue to see the current spread environment, we could see several hundred billion euros of supply above natural redemptions. If spreads back up, such plans will likely be shelved.”
The ECB’s mantra of doing “whatever it takes” has made the last few months of 2012 a much more comfortable environment for banks.
The iTraxx Senior Financials index has halved from a high of 302bp at the start of June to 147bp on Tuesday. Core banks can now issue covered bonds 15-20bp tighter than ECB funding and there has been a flurry of two-year FRNs from French and Dutch banks pricing inside ECB interest rates.
Meanwhile, a number of peripheral banks that have taken advantage of stronger conditions to make their capital markets return have said that reimbursing the ECB was an important consideration when planning their deals.
In November, Banco Espirito Santo issued the first public senior Portuguese bond for two years with a EUR750m three-year issue.
Two weeks later, Bank of Ireland got a EUR1bn covered bond out the door, bolstering further hopes of rehabilitation for peripheral issuers. Since then, Portuguese state-owned bank Caixa Geral de Depositos and Allied Irish Banks have both returned to market and Bank of Ireland has raised subordinated debt.
Analysts at Barclays estimate that EUR200bn could be repaid by banks in the first quarter of 2013, with French banks potentially returning as much as EUR80bn and Spanish and Italian banks paying back EUR30bn-40bn and EUR40bn respectively.
They note that for the 523 banks that borrowed EUR489bn at the first LTRO, the first day for early repayment is January 30 2013. For the 800 banks that borrowed EUR529bn at the second LTRO, the exit option can be exercised on February 27 2013.
For banks that want to cut their reliance on central bank funding, they need to do it now. As JP Morgan’s Marks put it, managing a large bank’s balance sheet is like steering a super tanker. “If you’re thinking about your position in 2015, you have to start moving now,” he said.
Meanwhile, national central banks may also exert more pressure on local banks to return to primary markets if issuance costs continue to fall.
However, not everyone agrees that banks will rush to pay back ECB money.
“You could argue it makes sense for some core banks to repay the LTRO money, both from a cost perspective and to avoid this large potential refinancing demand in 2015,” said Demetrio Salorio, global head of DCM at SG.
“Still, it is very hard to predict with any certainty what proportion of the EUR1trn LTRO money will be refinanced. The sovereign crisis is far from over; there are still clouds on the horizon in the form of Italian elections and a potential Spanish bailout.”
He added that should there be a clear improvement in the first quarter, then banks may repay more LTRO money as the year progresses. “But at this stage it’s hard to say,” he said.
Other observers argue the temptation to keep hold of this ultra-cheap cash as an insurance policy against further market disruption will prove too great for many bank treasurers.
“I think most banks would be wrong to re-pay the ECB money early. Right now they have enormous flexibility, with the ability to substitute pledged collateral or cancel virtually whenever they want. Why would you want to give that up?” said Mauricio Noe, head of senior and covered bonds at Deutsche Bank.
Bankers also point to the hefty premium paid by peripheral issuers to tap public markets. BES, for example, had to shell out a 5.875% coupon on its three-year deal.
Also, the fact that there is no way to know what the EUR1trn of LTRO money was used for in the first place makes it hard to predict how exactly it will impact volumes. JP Morgan analysts estimate only a third of it went towards redemptions.
Furthermore, banks ploughed a large chunk into carry trades, while it is thought some firms used local subsidiaries to borrow from peripheral national central banks to hedge against euro re-denomination risk.
The fact that European banks are deleveraging also means that overall funding needs are greatly reduced. JP Morgan analysts estimate that the European banking sector has shed EUR3.2trn of assets between the third quarter of 2011 and the second half of 2012. (Reporting By Christopher Whittall, Editing by Helene Durand and Julian Baker)