It seems we have something of an answer as to how Irish banks expect to get through the €30bn funding cliff this month. In the Irish Times today:
IRISH NATIONWIDE has issued €4 billion of Government-guaranteed bonds effectively to itself. It can use the bonds to draw €4 billion in funding from the European Central to help tide it over a key refinancing period later this month.
The building society has €4 billion of debt covered under the original blanket Government guarantee maturing at the end of this month. The bonds will allow the building society to draw fresh funding from the ECB if necessary to repay this debt against a backdrop of heightened funding pressures across the guaranteed institutions.
So what does that mean? Irish Nationwide is issuing bonds (these ones) and then using the bonds as collateral to borrow from the ECB marginal lending facility (MLF), also known as the discount window.
This is not dissimilar from the practice we learned of last week where nationalised bank, Anglo Irish, is using promissory notes issued by the Government as part of recapitalisation (ostensibly long term), as collateral with our own Central Bank in order to fund itself (they dare not go to the ECB?), at a rate of 1:1. This appears to have gone relatively unnoticed, and is buried in Anglo’s interim report, referred to as the Special Master Repurchase Agreement, which comes on top of the Master Loan Repurchase Agreement.
Expect to see other Irish bank create fictitious money in order to fund themselves via the discount window.
It also seems that this type of transaction is nothing new. Back before the September 2008 crisis, it seems that Lehman Brothers were doing something similar. Per the FT back in April 2008:
It was rather elliptically suggested by Bloomberg (from a Morgan Stanley analysis) that Freedom’s notes had been used as collateral by Lehman in the Fed’s primary dealer credit facility. And that that was – in the main – the reason the CLO had been created and successfully closed.
But there’s some confusion. In this article, Bloomberg say Lehman sold the $2.2bn of senior notes in Freedom “in a private placement”, which can’t be true if they’re being used in repos with the Fed by Lehman. As for the equity tranche, it’s unrated, so the NY Fed won’t accept it as collateral.
The WSJ reports that only some of the senior notes may actually have been pledged to the Fed. The small amount was supposed to “test” what the Fed would accept.
Since the test seems to have gone well, can other banks be expected to jump on the CLO bandwagon? JP Morgan is understood to be doing just that – with rumours of senior notes of a recently closed CLO being pledged in the PCDF.
But even if Freedom, and other CLOs, were created with the express intent of pledging notes to get liquid collateral through the PCDF, so what?
And it wasn’t only in the US this was happening. In the UK these are referred to as ‘phantom securities’:
In the depths of the financial crisis, the Old Lady began expanding the bank collateral eligible for use at its various liquidity operations, and starting new ones up. Unsurprisingly, given market conditions at the time, banks flocked to make use of the facilities. In fact, they began creating things specifically for use at the BoE, which the Bank gave the attention-grabbing title of ‘phantom securities.’
Some day, we will eventually we will have to confront reality, and stop this merry-go-round of fiction.
