Selasa, 03 April 2012

Demise of European Bank debt and Sovereign debt as well.....

On The Demise Of European Bank Debt

Tyler Durden's picture

While the LTROs were supposed to bring European banks back from the edge of insolvency with a warming blast of liquidity, the sad truth, now that the exuberance of fresh money-printing has faded, is that the unintended consequence has crammed down the senior unsecured bank debt holders to the lowest of the low. This realization, that we have discussed a number of times - most recently here - that nothing has been solved - as the LTRO Stigmaunintended consequence, is starting to leak back into broader risk premia as now the contagion risks are back on the table and even non-LTRO-facing banks are seeing spreads increase as expectations of either broader forced cram-downs or interconnected vicious cycles rear their ugly head once again among European banks - and implicitly back onto European Sovereign balance sheets. Citigroup's Hans Lorenzen highlights four key reasons for the increasingly binary bifurcation that senior unsecured bank debt has become.

Step 1: Vicious Cycles in Financial, Sovereign, and 'Real Economy'- briefly stymied by LTRO Hope but last week's macro data indicates the ongoing negative feedback loop between Austerity and Economic Contraction continues...
Source: Barclays
Step 2: LTRO fixed short-term liquidity issues in hopes of solving long-term insolvency issues but in the meantime the unitended consequence crammed down existing unsecured creditors...
Source: Citi
Step 3: But this has led to the LTRO Stigma as this cram-down and subordination was priced into LTRO-facing banks first (the LTRO Stigma that Draghi lied and said was not present) and now is creeping across into non-LTRO facingbanks as the vicious cycle from above starts to re-appear - as we also note the last week or so that short-term EUR-USD basis swaps have stabilized (stopped improving) and in fact 1Y basis swaps have started to deteriorate once again...
LTRO Stigma has exploded and non-LTRO banks are starting to creep wider too...
And perhaps more worryingly EUR-USD basis swaps are starting to creep weaker once again...
Chart: Bloomberg
Step 4: Leaving unsecured bank debt holders with a very binary payoff as the four realities of the new rules in Europe will surely leave non-government investors questioning the investment:
As a Bank bondholder:
  • You now sit towards the bottom of the capital structure
  • You're in a much thinner slice than you used to be
  • The quality of your asset pool has deteriorated
  • The correlation of your asset pool has risen sharply
Source: Citi
All-in-all - The LTRO stigma trade seems the best way to play and its becoming a major driver of equity performance as Italian banks hit YTD lows.


Restructuring the Irish promissory notes

In 2010 the Irish government bailed out (recapitalized) the Irish banks with 30bn euros. The government could not easily raise these funds in the market so it used promissory notes (PNs) instead of cash (sort of what California did when they paid salaries with IOUs during their "budget issues" in 09). These PNs are set up to pay a set amount over the next 20 years.

The promissory notes were used as collateral with the Central Bank of Ireland to obtain central bank emergency financing called ELA. That collateral did not qualify for LTRO, leaving ELA balances outstanding. Since then the banks were "restructured" creating the Irish Bank Resolution Corporation (IBRC) - the "bad bank" to hold all the wonderful real estate loans and properties. Now IBRC owes the Central Bank of Ireland money under the ELA.

This year about EUR 3.1bn of PNs was due (on March 31st), but the Irish government was in no position to pay that in cash. Instead the goal has been to kick the can down the road - as far as it can roll. The Finance Minister Michael Noonan has been trying for a while to restructure the PNs by swapping them into long-term government bonds. His negotiations with the EU/ECB have yielded only a partial result. He was able to roll just the 3.1bn due this year, but it required a fairly messy transaction. The issue is that the ELA financing is meant to be a temporary measure and the ECB wants it paid down asap.Here are the steps for the restructuring of the PN - just the EUR 3.1bn (this time around - no guarantee this will work next time): 

1. The Government issues a long-term bond that it delivers to IBRC in return for IBRC extinguishing the 3.1bn worth of PNs (it effectively pays its "promise" with long term bonds instead of cash).

2. IBRC places the bond as collateral with the Bank of Ireland (not to be confused with the Central Bank of Ireland) to borrow cash for a year. Given that the Bank of Ireland is controlled by the government, it can roll this loan indefinitely.

3. IBRC uses the cash from the loan to pay down the ELA financing and get back the PN it had out with the Central Bank of Ireland.

4. The Bank of Ireland then uses these long-term bonds as collateral to borrow from the Central Bank of Ireland/Eurosystem under the MRO or 3m LTRO programs.

Restructuring of Irish promissory notes

With this transaction, the Irish government doesn't have to use cash to pay the promissory notes, the Bank of Ireland makes a spread between where it borrows from the central bank and what it receives from IBRC, and the ECB makes sure that the ELA is paid down. Everyone is happy, right? Not exactly. This is a difficult transaction and Michael Noonan would much rather have used financing from EFSF directly. Most importantly, this is only a portion of the PN restructuring and this issue will be back shortly when the next portion of the PN is due. In 2014 the PNs due will constitute some 15% of projected cash needs of the Irish government. 

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