In December 2011 and February 2012 the European Central Bank flooded the market with €1tr of liquidity through its three year longer term refinancing operations (LTROs).
At some point this flood of money will hit its high water mark and start to recede. Banks that borrowed from the ECB and reinvested in their own government bond markets will want to take profits while the going is good and repay as much debt as they can.
At the start of 2012 investors were buying anything that offered a spread pick-up in the short end of core markets. But by the end of the year issuers like Münchener Hypothekenbank could fund even more cheaply in public markets than borrowing from the ECB.
With core issuers offering measly yields, investors with hard return targets had little choice but to seek more generous spreads.
By November, Intesa Sanpaolo was able to issue the first 10 year covered bond from a peripheral bank in over a year.
In senior unsecured, Banco Espirito Santo and Caixa Geral de Depósitos brought the first Portuguese deals in three years, while Bank of Ireland and Allied Irish Banks issued the first non-government guaranteed bank debt since the Irish sovereign bail-out.
These transactions were all made possible by the sharp decline in sovereign bond yields — a move artificially fuelled by ECB’s extraordinary liquidity injections.
Portuguese five year yields collapsed from around 17% in January to 6%. Italian 10 year government bonds tumbled from 7.5% in December 2011 to 4.4% now. Spanish 10 year yields have declined by about a third since July, when they peaked at 7.75%.
For the time being, the party is still going strong. Peripheral sovereign debt yields are converging towards Germany and with proceeds of the LTROs not due to be repaid until 2015, banks have not yet had to think seriously about how they will repay the money.
But 2013 is less than a month away and the clock is ticking. At some point, bank treasury officials will no longer be enjoying their free party but will have to start considering how to avoid the cliff of refinancing risk.
They will increasingly be thinking about accessing the public market, repaying the ECB and maybe even taking profits on their domestic sovereign debt exposure.
Since the ECB will want to encourage the challenged banks to get market funding it is unlikely to signal another big dollop of liquidity until it absolutely has to.
The longer it remains silent on a third possible LTRO, the more treasurers’ minds will focus on repayment. Once they start to sober up, the party will come to an end.
No one wants to move too soon, but, as always when trying to spot a high water mark, you’ll only be able to see it after the tide has turned. Too soon might well be better than too late.