Three year LTROs: Repay or delay?

Nov 22nd, 2012

The level of euro liquidity due to bank borrowing from the European Central Bank (ECB) has not been making headlines since the two three year longer term refinancing operations (LTROs) last December (Eu489.5bn) and February (Eu529.5bn).

It is almost a year since the first of the two was offered, so headlines related to the three year operation could be made once again, as the door opens for banks to return the cash early. Banks will be able to return some or all of the borrowed three year LTRO money at weekly intervals coinciding with the settlement of the MRO (main refinancing operations).

Who took what at the 3Y LTROs?

Precise 3Y LTRO take-up data is not available, but our estimates show that Italian and Spanish banks were the biggest participants in the operations. The reasons for banks participating in the LTROs varied, but can be divided into three categories: 1) banks that genuinely needed the money; 2) banks that took money as a precaution; and 3) banks that saw this as an opportunity to borrow cheaply and lend at comparatively favourable levels.

We suspect the first group of banks is least likely to return the money, while other groups may feel the moderately healthier banking environment (banking union in the pipeline) and the tighter spreads (less favourable carry trades) could make early repayment a serious option.

Incentives to keep LTRO money

  • Debt redemption pressures/lack of access to capital markets: While some banks are able to refinance themselves in the capital markets, many are heavily reliant on the ECB to refinance upcoming debt redemptions.
  • Borrowing terms at LTRO are favourable: The cost of funding in the capital markets is much higher than the use of the ECB’s LTRO, even after accounting for the haircut.
  • Lack of confidence/transparency: This is very much a qualitative reason for keeping hold of the LTRO money and will depend greatly on events at the political level in particular.

Incentives to return LTRO money

  • Deleveraging: Regulatory pressures and deteriorating financial health have seen banks shrink their balance sheets. This is an ongoing process and could see LTRO money being given back.
  • Releasing tied-up collateral: Although LTRO terms may be favourable compared with capital markets, the tying-up of collateral may outweigh the benefits of lower interest rates. However, the ECB does allow collateral substitutions, thus diminishing the likelihood of a collateral-driven payback of LTRO funds. Moreover, much of the increase in collateral since 2011 was in non-marketable assets.
  • Cost of carrying extra liquidity: Carrying extra liquidity, even at the Refi rate, is an expense that a bank could do without. However, borrowing conditions have not improved to the extent that counterparty lending is taking place at a similar tenor to the LTRO.

What are banks capable of paying back, in theory?

We put together some estimates of how much flexibility the main national banking systems might have in returning LTRO funding. As a very rough estimate, and allowing for deleveraging, we think banks would have the scope to return a maximum of between Eu300bn and Eu400bn next year, in theory.

How much will banks repay?

For the coming year, we think most banks will keep their 3Y LTRO cash on the basis of debt redemption pressures and cost of funding in, or lack of access to, capital markets. On balance, after considering the data and the likely mood of ongoing cautiousness, we believe they will return initially Eu100bn-Eu150bn by end-H1 13. This could accumulate to Eu200-Eu250bn by end-2013.

What is the impact of LTRO payback?

  • ECB monetary policy: We think that the volume of 3Y LTRO funds paid back should have only limited implications for monetary policy decisions. We believe the biggest factor for determining policy rates in the longer term will be the ongoing process of the restoration of monetary transmission channels.
  •  Interest rates: The greater the pace of LTRO funds paid back, the steeper the Eonia strip is likely to be, as there will be an increasing degree of optimism towards the prospect of “normalisation”.
  • Credit: While any signs of normalisation in bank funding (i.e. returning of LTRO money) should be construed as positive, the marginal impact on credit spreads across the sector as a whole is likely to be limited. The greatest impact would be on peripheral banks who choose to return LTRO money, but they would be less likely to be in a position to do so.


Orlando Green, CFA, Senior Interest Rate Strategist
Harpreet Parhar, CFA, Credit Strategist
Crédit Agricole CIB


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