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Distressed corporate debt: The end of extend and pretend

Refinancing options are running out for many European companies with looming debt maturities. Could the banks’ own funding problems finally precipitate the distressed debt opportunity this market has been waiting for? Or are the consequences of asset disposals too brutal for many banks to take?

As the ECB faces the uncomfortable reality that its three-year LTRO largesse might not be devoted to propping up the sovereign bond markets, it must be fervently hoping it has more luck with plan B. This involves banks using the cheap loans they have been given for corporate – particularly SME – lending in Europe, thereby averting a renewed credit crunch for the region’s companies.

So far, the signs are not encouraging. Data from the ECB show that while a bumper €489 billion was lent out to 523 banks in December, by January overnight deposits with the central bank had hit a record €486 billion. So there is a worrying chance Plan B might not be working either.

Given that banks are facing a much-touted €300 billion of first-quarter redemptions, it would make a lot of sense for them to use the cheap ECB liquidity to address this issue rather than gamble with a sovereign bond carry trade.

Indeed, while the LTRO has triggered an increase in peripheral debt demand, this might simply be banks loading up on collateral to prefund their debt-refinancing needs.

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