Friday 9 December 2011

ECB adopts ELA practices, Stealth Quantitative Easing

ECB Decides that it is really a bad bank after all.

The ECB decided on Thursday to:
  • Lower the Repo, Marginal and Deposit rate to by 25bp.
  • Start a longer-term refinancing operation with a maturity of 36Months putable after 12m. 
  • Reduce the reserve ratio from 2% to 1% (Banks would need 100blin less now to cover their regulatory requirements)
  • Lowered the collateral rules for ABS (single A, Mortgages and SME’s) and allowing NCB to accept performing loans
Lets look at each of the decisions.

  • Lowering the Repo by 25bp was expected and it shouldn’t make much impact in the market. It does help the banks by lowering the price of money.  
  • Starting a 36month LTRO can be seen as a proxy for quantitative easing. The tender would be on a fixed rate basis with Full Allotment. Banks would effectively repo their holding for up to 3y with the option to cancel it after 1Y and every settlement date thereafter. It is equivalent to buying the securities, since many of them have less than 3Y maturity. Thus for many it would be a Repo to Maturity! This may mean the following
    • For Banks that have the bonds on an accrual basis it would mean writing constant profits as bonds are pulled to Par and of course do not default.
    • It would also allow them to bypass the mark to market. This may echo the practice of Mr Corzine in the failed MF Global, but the repo counterparty now is the ECB. In other words, ECB would not pull the plug on them.
    • Presumably, once they mature they would be replaced by new ones.
  • Reducing the regulatory requirement from 2% to 1% also helps the banks that have run out of collateral. Now, they only need to come up with half of the collateral. Thus contrary to claims by the former ECB governor that Europe has no collateral problem, Mr Draghi has taken the opposite view. In fact, Europe is so short of collateral that the ECB has lowered the thresholds again. 
  •  The Governing Council of the ECB also decided to accept ABS with a second rating of A, provided it consists non-structured, performing Mortgages or SME’s (Leveraged or syndicated are excluded). Also excluded are ABS where the repo-ing bank is closely associated with the ABS swap (swap whereby the Bank takes back the mortgages and pays floating). This is done so as to reduce the ECB exposure to both the ABS and the bank.  
    •   Most importantly, the ECB allowed the NCB to accept performing loans as collateral. This effectively moves all the ELA assets back on the balance sheet of the ECB. In other words, the ECB has now fully endorsed the ELA practice. NCB’s would no longer need approval and we should expect a reduction of the ELA assets that are the liability of the Country.
    • Furthermore, the ECB appears to have relaxed the ratings rules by welcoming internal credit assessments in the Eurosystem. This could mean that any credit claim is acceptable as collateral.

In our view, the ECB has now come to terms with the notion of being the largest bad bank in Europe. Not only it has lowered the collateral rules once more but it would also accept assets that previously were only acceptable in the ELA operation. This should be great news for Ireland and Greece (26 36.3bil in ELA and growing). It also means less to pay as the ELA is charged at the Marginal rate plus a spread. Now, banks need only pay the repo rate at 1%.
The ECB has for the first time adopted Quantitative easing but called it Longer term LTRO. The Fed and the BOE are openly doing quantitative easing by purchasing outright securities. The ECB has chosen instead to do Repo to Maturity for at least 3Y. Given that trillions of government bonds mature in the next 3years this is for all practical purposes ECB’s stealth Bazooka. Now it is time for the European politicians to play ball.