PARIS (MNI) – Banks are expected to borrow around E500 billion at
the European Central Bank’s three-year refinancing operation on
Wednesday, with demand for new liquidity substantially larger than at
the previous three-year operation in December, analysts said.

At the December LTRO, banks borrowed E489 billion, of which about
E191 billion represented new cash and the remainder rollovers of banks’
existing loans with the ECB.

This week, banks’ demand for new cash could top E300 billon,
analysts said, as concerns have eased that big ECB borrowing could be
seen as a sign of financial weakness. As a result, banks are free to
stockpile liquidity as insurance against future turmoil or to plow more
funds into government bond carry trades.

“The LTRO is offering relatively cheap money and there is very
little stigma around taking it,” said Bruce van Saun, finance director
at Royal Bank of Scotland, at a press conference last week.

And the larger share of new money provided by the LTRO “is what
really matters in terms of refinancing needs, carry trades and new
lending,” said analysts at Deutsche Bank in a research note.

The gross take-up could still have a significant impact in terms of
market sentiment, however. A total allotment of less than E400 billion
would signal less future demand for riskier peripheral assets and might
trigger a sell-off in Portuguese, Spanish and Italian bond markets.

The ECB’s first LTRO has proved to be a game-changer for peripheral
markets. Since December 21, Italian 10-year bonds yields have fallen
from 7% to 5.38%, while Spanish 10-year returns have dropped from 6.3%
to 5%. Huge demand at Spain’s debt actions, possibly from banks using
ECB money to execute carry trades, has allowed the Spanish Treasury to
complete 32.4% of annual funding need in only two months.

This week’s LTRO is also likely attract bids from banks that did
not participate the first time around, like Britain’s Lloyds Banking
Group, amid growing expectations that the ECB will not repeat the
operation a third time unless the debt crisis worsens considerably.

“It would make sense for our euro assets,” Lloyds’ chief executive
Antonio Horta-Osorio, said of participating in the LTRO, while
presenting the bank’s earnings last week.

Analysts say the number of banks tapping the ECB could rise
significantly from the 523 that borrowed at the December LTRO, due in
part to relaxed collateral rules at seven national central banks.
European auto companies, like Volkswagen and Peugeot Citroen, have also
indicated they may take part through their banking subsidiaries.

“It’s being seen as the last great shot at cheap credit,” said a
London-based money market trader.

Standard & Poors said in a research note that the end of such cheap
credit represents a risk for the banking system in the future.

“While the two three-year LTRO tenders establish a relatively long
period for the industry to adjust, the ECB exit, in our opinion,
represents a large risk that will grow over the coming three years as
the first quarter 2015 maturity of the three-year LTRO approaches,” S&P
said.

–Paris newsroom, +33142715540; jduffy@marketnews.com

[TOPICS: M$$CR$,MT$$$$,M$X$$$,M$$EC$,M$X$$$]