30/5/16: ECB's TLTROs, via Expresso

Portugal's Expresso on ECB's TLTROs programme, with quotes from myself (amongst others):

11/12/2014: TLTRO2: Misfiring that Bazooka... Again

Second round of TLTROs take up at EUR129.84bn. Prior market consensus expectation was for EUR130bn, with range of EUR 200 billion 'bulls' expectation and EUR 100 billion 'bears':

- Morgan Stanley at EUR120-170 billion, 

- Deutsche at EUR170 billion

- Citi at EUR165 billion

- BNP at EUR140-180 billion

- JPM at EUR190 billion

- BAML at EUR130 billion

So 'bears' have it. New tranche of TLTROs as expected better than the 1st tranche (http://trueeconomics.blogspot.ie/2014/09/1892014-quite-disappointing-tltro-round.html) but still disappointing. Back in September, I expected two tranches to amount to close to EUR300 billion. We now have less than EUR213 billion. This is a massive undershooting on expectations for majority of markets analysts. One of Draghi's 'big bazookas' is currently misfiring charcoal instead of bullets, placing more pressure on the ECB to get into QE-like actions in January.

25/9/2014: IMF Dished Out Some Bad News on Italy... here's a snapshot...

Recently IMF released Article IV consultation paper on Italy. I have missed posting this note for some days now due to extensive travel, so here it is, with slight delay.

A depressing read both in terms of current situation assessment and prospects for the medium term future. Which is hardly surprising.

Key struggles are, per IMF: "Exports have held steady, led by demand from non-EU countries, but investment continues to decline and remains 27 percent below pre-crisis levels."

 

Err… actually no… exports are still below pre-crisis levels by volumes, never mind price effects on value. Exports of goods and services grew by 6.2% in 2011, but then growth collapsed to 2.1% in 2012 and 0.1% in 2013. 2014 projected growth is for healthier 3.0%, and thereafter the Fund forecasts exports to continue expanding annually at just under 3.6% pa on average between 2015 and 2019. Which is handy, but not exactly 'booming'. And worse, net exports having grown by 1.5% and 2.6% in 2011 and 2012 have shown decline in the growth rates to 0.8% in 2013 and projected 0.5% in 2014. Thereafter, net contribution of external trade to GDP is forecast to grow at 0.4% in 2015 and 0.1% every year from 2016 through 2019. Again, this is weak, not strong. And keep in mind: GDP does not grow with Exports, it grows with Net Exports.

Fixed investment is, of course, still worse. In 2011 gross fixed capital formation shrunk 2.2%, followed by an outright collapse of 8% in 2012 and topped by a decline of 4.7% in 2013. Now, the Fund is projecting contraction of 1.1% in 2014, but return to growth in 2015 (+1.8%) and in 2016-2019 (average annual rate of expansion of ca 2.6%). Which means one simple thing: by the end of 2019, investment in Italy will still be 6.2% below the pre-crisis levels.

Now, the IMF can be entertaining all sorts of reforms and changes and structural adjustments, but there is one pesky problem in all of this: investment is something that the young(er) generations tend to do. And Italian young (people and firms) have no jobs and little churn in the marketplace to allow them grow, let alone invest. IMF notes low churn of firms… but misses the connection to investment. 

And, of course, it misses the Elephant in the proverbial Room: Italian families are settled with 30-40 year old sons and daughters still living on parental subsidies. Now, parents are heading for retirement (tighter cash flows) and retirement funds are heading for if not an outright bust, at least for gradual erosion in real value terms. What happens when retired parents can’t nurse their children’s gap between spending and earning?..

Things get uglier from there on. Not surprisingly, due to debt overhang already at play, credit supply remains poor and NPLs continue to strain banks balance sheets. This is holding back the entire domestic demand and is exacerbating already hefty fiscal disaster.

There is no life in the credit market and with this there is no life in the economy. Which, obviously, suggests that credit is the core source for growth. This is not that great when you consider that there are four broadly-speaking sources of investment (and capacity expansion):

1. Organic revenues growth (exports are barely growing, domestic consumption is dead, so that's out of the window);
2. Direct debt markets (bond markets for corporate paper, open basically only to the largest Italian corporates and no smaller firms access platforms in place, which means no real debt markets available to the economy at large);
3. Equity (forget this one - tightly held family firms just don't do equity, preferring to cut back on production) and
4. Banks credit (aka, debt, glorious debt).

Chart above shows the relationship between Financial Conditions Index (FCI) and economic growth. FCI breakdown is shown in chart below:

All of which confirms the above: improvements in the credit volume and credit standards are being chewed up by the ugly nominal rates charged in the banking system that is now performing worse (in terms of profitability) than its other Big Euro 4 + UK counterparts.

And the IMF notes that: "Financial conditions are closely correlated with growth and FCI shocks have a significant impact on growth. For example, a bivariate VAR under the identifying assumption that the FCI affects growth with a one-quarter lag suggests that a negative shock that raises real corporate lending rates by 260bps through a 200bps increase in nominal rates and a 60bps decline in inflation expectations (to 0.5 percent), would lower growth by a cumulative 0.4 percentage point over three quarters. As a reference, real rates have increased by around 300 bps since mid-2012." No sh*t Sherlocks, you don’t need VAR to tell you that growth in Europe = credit. It has been so since the creation of the Euro, and actually even before then.

Now, do the math: in 2013, Italian banks have posted profitability readings that are plain disastrous:

The swing between ROE for Italian banks and Spanish & French counterparts is now around 21 percentage points. While NPLs are still climbing:

But real lending rates are above those in France and below those in Spain:

Taken together, charts 4-6 show conclusively that nominal rates will have to rise AND deleveraging out of bad loans will have to either drag on for much longer, or worse (for the short run) accelerate. All of which means (back to the above IMF quote) continued drag from the financial sector on growth in quarters ahead. Everyone screams 'austerity' but really should be screaming 'deleveraging':

IMF notes: "The analysis suggests that measures to normalize corporate financial conditions would support a robust and sustained recovery, mainly through investment. Since bank lending rates account for the lion’s share of the tightening in the FCI, domestic and euro area measures to address financial fragmentation, mend corporate balance sheets, and strengthen banks’ capacity to lend would minimize the risk of a weak, creditless recovery."

This is all fine, but totally misses the problem: financial 'normalisation' in the above context is not about investment, but about investment via debt. And more debt is hardly a feasible undertaking for Italian firms and for Italian banks. Supply IS closer to demand that we think, because tight supply (banks deleveraging) is coincident with tight demand (once we control for the risks of poorly performing corporates seeking debt rollovers and refinancing).

And, of course, the IMF optimism for “domestic and euro area measures to address financial fragmentation, mend corporate balance sheets, and strengthen banks’ capacity to lend” capacity have just hit a major brick wall at the TLTROs placement last. As subsequent data showed, Italian banks just started re-loading their hoard of Government bonds instead of repairing the corporate credit system. Who could have imagined that happening, eh?

22/9/2014: Where TLTROs dare to go?..

Last week I wrote about the disappointing nature of the first round of TLTROs by the ECB (http://trueeconomics.blogspot.ie/2014/09/1892014-quite-disappointing-tltro-round.html). Now, some more evidence that TLTROs are at best replacing / swapping liquidity in LTROs maturities without materially changing the nature of the banks assets holdings. Remember, the objective of TLTROs is to inject funds into corporate lending, not sustain or increase flows of funds into sovereign debt markets... which means sovereign yields should not be falling in connection to TLTROs.

So guess what's happening?

H/T for the chart to @DavidKeo

The chart above shows several things:

1. Both Spanish and Italian yields are falling across all maturities in excess of 1 year.
2. The margin from lending to the Spanish and Italian Governments (yield on bonds less cost of TLTRO funds) is lower across all maturities post TLTRO issue than before.
3. Margin declines are not uniform across maturities, and generally steeper at longer maturities. 

Are the banks taking up TLTROs pushing up prices of Government debt?.. That would mean more disconnection between the monetary policy objectives and outcomes, right?..

18/9/2014: Quite a disappointing TLTRO round 1

So ECB's first tranche of TLTROs allotted at EUR82.6 billion - which is disappointing to say the least. Announcement is here: http://www.ecb.europa.eu/press/pr/date/2014/html/pr140918_1.en.html

Prior to the allotment, the following were forecast:

• Credit Agricole: EUR100 billion (EUR200 billion into December tranche)
• Goldman Sachs: EUR200-260 billion in September and December TLTROs and EUR720-910 billion in overall programme
• Morgan Stanley: EUR250 billion in September & December TLTRO tranches and EUR100-400 billion for tranches 3-8
• Nomura EUR115 billion in September and EUR165 billion in December
• JPMorgan EUR150 billion in September
• Barclays EUR114 billion in September and EUR154 billion in December.

My own view on the subject as follows (from a comment given yesterday for international publication).

Note that the take up today has been disappointing for all above expectations (my own included), suggesting that traditional LTROs roll-overs dominated decision on TLTRO demand. This means that going into AQR reviews by the ECB the banks are reluctant to expand their corporate lending balance sheets and the loading now is on much heavier take up of TLTROs in December. In the mean time, low take up in this tranche can put some added pressure on ECB to deploy its ABS purchasing programme.


TLTROs vs LTROs

The key difference between TLTROs and LTROs is in the targeted nature of TLTROs. Conventional LTROs (despite the fact that term 'conventional' can hardly apply to these rather exceptional instruments) are unrelated to the balancesheet exposures of the banks and are designed to simply inject medium-term and long-term liquidity into the banking system as a whole. Thus, in the environment of deleveraging and uncertainty with respect to future losses, LTRO-raised funds flow to government securities with lower / zero risk-weighting and high liquidity. The effect is to reduce yields on Government securities, without providing any meaningful uplift in lending to the real economy. De facto, LTROs helped alleviate the sovereign debt crisis on 2010-2011, but also resulted in increased credit markets fragmentation and did nothing to reduce credit supply pressures in the real economies of the euro area countries. TLTROs - via targeting levels of real credit exposures to non-financial corporations - are holding a promise to shift funds into credit markets for companies, with weighting formula favouring banks with greater exposures to such lending. If successful, TLTRO programmes can incentivise banks to lend on the basis of risk-return valuations, which can, in theory, also alleviate the problem of financial markets fragmentation by attracting euro area banks into lending in the so-called 'peripheral' economies.

At this stage, both demand and supply of credit in the majority of the euro area economies are well outside the fundamentals-determined levels. The financial markets are severely fragmented and the ongoing deleveraging of the banks and companies balancesheets still working through the credit markets. This means that any forecast for TLTROs uptake and effectiveness are subject to huge uncertainty. My view is that we are likely to see rather cautious take up of the TLTRO funds in the first round, with many lenders dipping into the funding stream without full commitment. We are looking at the take up of around EUR100-150 billion in Thursday TLTROs. One reason for this is that the first tranche of TLTROs is likely to go into replacing maturing 3-year LTRO funds rather than new expansion of the banks balancesheets. To-date, banks repaid some EUR649 billion of LTROs, with EUR370 billion outstanding. Close-to-redemption LTRO funds need replacement and TLTROs are offering such an opportunity, albeit at a cost (TLTROs are priced 10bp higher than LTROs but offer longer maturity). All-in, the banks are likely to go for roughly EUR300 billion of TLTROs (with total potential allotment of EUR400 billion available, the cost will be the main factor here), with under half of this coming in September and the balance in December. Another reason pushing TLTROs demand into December, rather than September, is the ongoing ECB review of the banks (AQR analysis).

TLTROs, ABS and QE

ABS measures are going to aim to address the size of the ECB balancesheet, while providing support for effective yield on loans to the real economy. In this, well-structured ABS purchasing programme can provide support for TLTROs by increasing incentives for the banks to lend funds to corporates. However, excessive focus in the ABS programme on quality of assets and risk pricing can posit a risk of increasing fragmentation in the markets, as such focus can drive a significant wedge in pricing between corporate yields in the core economies of the euro area and the 'periphery'.

I do not see the ECB deploying traditional QE programme at this point in time. The reason for this is simple: yields convergence in the Sovereign markets is ongoing, levels of yields are benign, and demand for sovereign assets remains strong. However, if TLTROs and ABS programmes prove to be successful, we may see banks exits from low-yielding sovereign debt (core euro area) and from high yield, but now significantly repriced peripheral debt (profit taking). Unlikely as this might be at this point in time, if such exits prove to be aggressive, the ECB will have to provide support for sovereign yields and a small-scale QE can be contemplated in this case.

In general, however, it is clear from Mr Draghi's recent speeches and statements that he sees two key problems plaguing the euro area economies: the problem of high structural and cyclical unemployment and the problem of low private investment. Both of these problems continue to persist even as the sovereign debt yields have fallen dramatically, suggesting that government spending stimulus and investment programmes are unlikely to repair what is structurally a longer-term set of weaknesses in the economy.