The ECB moves to tame the TLTRO program
Bank funding in recent years has depended heavily on central bank funding. The third Target Long-Term Refinancing Operation (TLTRO-III) reached maturity with €1,490 billion of its outstanding balance maturing in the course of 2023. Part of the funds will be repaid before maturity. The ECB announced changes to the terms of the TLTRO-III program at its October meeting, meaning the cost of the program for banks will increase.
From 23 November 2022 and until maturity or early repayment, the TLTRO interest rate will be indexed to the average ECB key interest rate applicable throughout this period. The change means the cost of TLTRO tranches for banks that have met the lending benchmark will move to at least 1.5% after 23 November (to the level of the deposit rate on 2 November), but the level for the rest of any tranche is likely to be higher than this because the ECB keeps raising rates. Until November 23 banks can enjoy very attractive rates based on the average over the life of the tranche up to that date. The ECB is also offering banks additional voluntary early repayment dates.
Changes in funding programs mean that not all banks are in the same position. Banks that have increased their long-term funding due to this program will have more difficulty paying them early than names that have used funding in a more opportunistic way in short-term commitments.
Although operating costs will be higher for banks, the level compares favorably with bond market yields
Although operating costs will be higher for banks, the level is still attractive relative to bond market yields following a major repricing of base interest rates this year. Most covered instruments trade with yields closer to 2.8% in the 2024 maturity bucket, while preferred seniors are priced even at higher yield levels than this (around >3.6%). Therefore, even if the ECB has changed the conditions, we do not expect the changes to result in massive early repayments for banks that use operations for funding. Instead, these banks are likely to consider the benefits of maintaining more liquidity, especially given the significant volatility in financial markets and concerns over the economic outlook.
For banks that have issued funds more opportunistically, the question is less clear. Although you can continue to redeposit funds at the deposit rate to the ECB, drawing a TLTRO has a negative impact on for example MREL or leverage ratio metrics. That said, the cost of holding funds seems insurmountable to us, at least for now. Early repayment will reduce liquidity buffers at times of significant stress in financial markets. Some banks will lower this buffer to repay early while others may choose to wait. A large early repayment still this year, for these reasons, may be less likely in our view.