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Spanish Banks Face Bond Losses in LTRO Aftermath: David Powell

Posted by WARREN MOSLER on April 11th, 2012

Looks like it was at least the Spanish banks that got the nod to buy their govt’s bonds when the LTRO was announced.

Problem is they can only buy them to the extent their capital allows, and as raising more capital isn’t happening, it was probably a one time buying binge.

That’s why subsequent LTRO’s won’t do much for banks whose capital is already fully extended.

And losses serve to weaken their capital positions.

Spanish Banks Face Bond Losses in LTRO Aftermath: David Powell

By David Powell

April 11 (Bloomberg) — The European Central Bank may have pushed the Spanish banking system closer to collapse through its three-year longer-term refinancing operations.

Banks in Spain have been saddled with losses of about 1.6 billion euros as a result of the liquidity operation conducted in December, according to Bloomberg Brief estimates. Spanish lenders purchased 45.7 billion euros of government bonds during the months of December, January and February, according to monthly data from the ECB, and the average of the current prices of two-, six- and 10-year government bonds of Spain is 3.5 percent below the average of the average of those prices from Dec. 22 to March 1. [Note: The prices for six-year bonds are used instead of those for five-year bonds because the price history for the current five-year generic government bond of Italy starts only in January.]

International assistance will probably be needed to break the cycle. Spanish sovereign yields surged last year as investors worried about the solvency of the state given unrecognized losses in the banking system linked to the real estate bubble. Interest rates later declined after Spanish lenders purchased government debt during those three months, probably with the proceeds of the first three-year longer-term refinancing operation. Those purchases are now creating additional losses for the banking system.

The losses stemming from those bonds were essentially transferred to the domestic banking system from private bondholders with the assistance of the central bank.

The damage may be mitigated by low levels of margin calls from the ECB. Deposits related to margin calls at the central bank totaled only 0.3 billion in the week ended April 4, according to the Eurosystem’s weekly financial statement.

That suggests commercial lenders posted assets as collateral that have maintained their values. Those probably consisted primarily of the “residential mortgages and loans to small and medium-sized enterprises (SMEs)”, which the central bank said were eligible for use in its Dec. 8 statement. Those illiquid assets may be unaffected by the mark-to-market process because there are no developed markets for them. The deposits related to margin calls probably would have risen if banks had posted government bonds as collateral.

The situation for financial institutions in Italy is less dire than for those in Spain. Italian government bond prices on average are 2.1 percent above the distressed levels at which they traded from Dec. 22 to March 1. That suggests Italian banks may be sitting on profits of about 425 million euros after they purchased 20.3 billion euros of government bonds during that period.

Losses for both banking systems would probably have been created if they purchased government bonds with the proceeds of the second three-year longerterm refinancing operation. The funds from the second auction are excluded from this analysis because it settled on March 1 and the latest data from the ECB on government bond purchases of euro-area banks runs through the end of February. The data for March will be released on April 30.

As Ronald Reagan quipped, “The nine most terrifying words in the English language are: ‘I’m from the government and I’m here to help.’”

9 Responses to “Spanish Banks Face Bond Losses in LTRO Aftermath: David Powell”

  1. roger erickson Says:

    Bank liability for the loans they approve constrains their loan volume … unless there’s some gov guarantee to bail out the banks … when & if something rational/irrational happens (depends on perspective). A quid pro quo promised or implied? If all emu countries go back to their own currency, most cross-border debts could be devalued away?

    Ireland’s gov voluntarily bailed out domestic banks, as well guaranteeing many foreign loans made withing Ireland? Practically every country except Iceland did.

    This may reflect a political battle for control of ECB policy? Do the recent German resignations indicate that their monetary camp is losing, or winning?

    I just can’t tell. Seems it could still go either way, and every country is positioning themselves for that?

    1973 marked the final repudiation of any form of gold-convertibility. 2012 may end the voluntary custom of national gov’s guaranteeing significant amounts of cross-border debts.

    Reply

  2. FIN Says:

    Warren, using ltro funds to buy sovereign debt, or any other assets, will not consume capital…if assets and liabilities rise equally net asset value remains the same…and goes up or down eventually if the trade makes or loses money.

    Reply

    FIN Reply:

    @FIN,
    That is assuming there is no capital charge in posting collateral.

    Reply

    Art Patten Reply:

    @FIN,

    Tangential, but has anyone seen this yet?

    http://ftalphaville.ft.com/blog/2012/04/12/946181/the-doom-loop-in-sovereign-exposures/

    Basel III, intended to make financial systems more robust, could cause sovereign CDS to blow out – !

    What is it Warren likes to say? The financial system is more trouble than it’s worth?

    Reply

    WARREN MOSLER Reply:

    the way I meant it is that lending reduces capital ratios and in that sense ‘uses up’ capital

    Reply

    Art Patten Reply:

    @WARREN MOSLER,

    “lending reduces capital ratios and in that sense ‘uses up’ capital”

    And there are tighter capital requirements looming this summer, which will ‘lock up’ more capital.

    Reply

  3. Art Patten Says:

    What does the Reagan quote at the end have to do with this story? Did I miss something?

    Reply

    WARREN MOSLER Reply:

    i didn’t get it either

    Reply

  4. LTRO operation is pushing Spanish banking system closer to collapse | Credit Writedowns Says:

    [...] This is what has happened. This quote from Bloomberg economist David Powell gets at both the magnitude of the bet on Spanish bonds and the magnitude of capital losses so far (hat tip to Warren Mosler). [...]

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