RPT-Fitch: U.S. repo market declines underscore possible policy risks

Fri Dec 20, 2013 8:47am EST

Dec 20 (Reuters) - (The following statement was released by the rating agency)

The U.S. tri-party repo market declined during 2013 amid regulatory developments and an uptick in interest rates last spring, according to a Fitch Ratings' report.

Figures available through early November show the U.S. triparty repo market declined $236 billion in 2013. A key driver was a 26% decline ($208 billion) in repos backed by agency mortgage-backed securities (MBS) and collateralized mortgage obligations (CMO). Over the same period, equities and structured finance collateral increased by approximately 21%, although this increase came from a lower base percentage. Equities and structured finance are generally lower quality but less interest rate-sensitive than Treasury or agency securities.

The overall tri-party repo market represents approximately $1.63 trillion as of Nov. 12, according to figures recently released by the Federal Reserve Bank of New York.

Fitch partially attributes the decline in agency MBS and Treasury repo to the interest rate rises that began in early May. For some fixed income investors, ensuing valuation losses on bond holdings were magnified by the use of leverage, particularly repos. Fitch notes that the future direction of U.S. monetary policy, including the Federal Reserve's quantitative easing (QE) program, is an important factor for agency MBS repo, influencing the amount of these securities available in the market and their valuations.

Potential regulatory constraints include the Basel III leverage ratio, which would increase repo capital charges relative to current risk-based rules, and the focus on 'fire sale risks,' if resulting in new regulations or supervisory limitations.

Haircuts, a measure of the degree of overcollateralization within a repo transaction, were little changed for the tri-party market in 2013. Median haircuts for both agency MBS and Treasurys remained at 2% throughout 2013, implying no change in leverage amid the uncertainties from interest rate volatility and October's debt ceiling impasse.

As policymakers address risks emanating from the repo market, they face a balance between mitigating the potential for 'fire sales' versus the utility of repos in providing liquidity and funding across a range of securities markets.

Indeed, for repo market participants, one of the main uncertainties is the evolving policy environment.

The full report 'Repos: Market Decline Amid Policy Risk' is available at 'www.fitchratings.com'.

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