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Increased Financing Costs A Certainty For Banks, Leading to More Uncertainty

erku's picture

The Wall Street Journal has a front page story on the amount of floating-rate notes that banks will have to rollover within the next few years. According to a JP Morgan analyst, financial institutions will have to pay off $787 billion in notes before the end of 2009.

A mere year ago, floating-rate notes were priced at .02 percentage points over Libor.

Investors are currently demanding more than 2.0% over Libor. The spread has widened so much primarily because SIV's used to be large buyers of these floating-rate notes. Remember SIV's? They went extinct with the Dodo bird.

For those who don't recall, SIV's were off-balance-sheet vehicles created by the banks to off-load assets to juice returns. The sad truth is that banks are having trouble finding buyers for their floating-rate debt because they can no longer sell it to themselves.

Where can the banks turn to find cheap financing? Why the Fed, of course, and the ECB if you happen to be a European Bank. As it turns out, the ECB has been far too friendly to the banks that have sought funds. It has been no secret that the ECB has been concerned about the type of collateral it was allowing banks to pledge against its loans. I wrote about this in a story on May 16, 2008 where I invented a mock scenario of how bankers are likely to game the Fed and the ECB.

Apparently, there is evidence that the ECB has been allowing the banks to price the collateral at higher prices than where it is trading in the market.

As a consequence, banks can carry these assets at artificially high prices while financing them at artificially low rates. Although it is quite possible that credit market conditions will improve and all of those billions in loans will be repaid to the Fed and the ECB within the next few years, another extremely likely scenario resembles the Danish Central Bank's takeover of Roskilde Bank.

The Danish Central Bank was forced to inject funds into Roskilde when it couldn't find a private buyer and didn't want to face the prospect of a financial meltdown in the banking sector due to a bankruptcy.

According to Danish Central Bank Governor Nils Bernstein, Roskilde's failure was "unique" and linked to a "very large exposure to the real-estate market." Unique? Large exposure to the real estate market? I wonder if I can think of any US banks that are borrowing from the Fed that have a very large exposure to the real-estate market. I wonder.

Reported by Mock The Market

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