Following the long-term refinancing operation (LTRO) of €489bn, there was a bated sense of anticipation that banks will binge on their national sovereign bonds, earning "carry" to boost profits. Net of refinancing due by the banks in 2012, it is expected that around €210bn of net new funding is available. Assuming the average sovereign issuance is at 5% and funding is 1%, there is a maximum potential for annual carry profits of €8bn per year or €24bn over 3 years. Given that banks have to raise €115 bn of net new capital by July 2012, the annual €8bn is clearly a drop in the bucket. This partially explains why the bulk of the €210bn surplus (€167bn to be precise) was re-deposited with the European Central Bank (ECB) at rates of 0.25%. So, instead of positive carry from buying sovereign bonds, banks are prepared to earn a negative carry of 0.75% to keep their balance sheet (appear) strong. Perhaps this is simply a year-end effect and banks will bring their cheque books into forthcoming sovereign auctions as quid pro quo for all the liquidity and guarantees they have been provided.
As an example, LTRO requires banks to deposit quality collateral - although the ECB recently relaxed the rule so that even the proverbial kitchen sink could be repo-ed against LTRO. Even so, it appears that some banks with balance sheets in the € trillions did not have unencumbered assets to pledge. Some Italian banks, who have in total borrowed around €40bn in the LTRO, have cunningly issued bonds to themselves, had them guaranteed by the Republic and then pledged these with the ECB to LTRO. Not quite cricket, I hear you say, but then this is Europe - they don’t know the rules of cricket (or care for that matter). This is survival.
This should warn us that 2012 is going to be a scary year. In spite of all the liquidity injected into the banks, banks will remain focused on survival and unprepared to lend to main street in a material way. In fact, sovereigns are busy lending to banks who are lending back to the sovereigns. Main Street is not even in the picture. Instead of cash, expect bullish rhetoric from the sell side to keep the market afloat.
Welcome to 2012, the year history books will likely tell us that the ECB officially launched (Quantitative Easing Euro) QEu, the Federal Reserve conducted (Quantitative Easing Three) QE3, the Euro went to Parity, Greece was thrown out and the curtains finally came down on the single Euro-zone experiment.