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NEW YORK Wall Street firms are finding it more expensive to fund their holdings of more than $100 billion in short-dated U.S. government securities and if the Federal Reserve doubles down on its efforts to keep long-term interest rates low, it could pinch those firms more.
There are pressures coming from several directions, the main one being the Fed's Operation Twist stimulus program. This is due to expire in less than two weeks but some say the central bank could decide to extend it at a policy meeting that ends on Wednesday.
Analysts say another factor is BNY Mellon Corp.'s (BK.N) increase in charges for credit associated with some Treasuries trading, a decision made as part of an industry drive to reduce reliance on borrowing for routine purchases.
Operation Twist involves the Fed buying $400 billion in longer-dated Treasuries in the open market, with these purchases funded by selling comparable amounts from its holdings of short-dated government debt.
Since the program began last October, the 21 U.S. primary dealers, the Wall Street firms that do business directly with the Fed, have been stuck with some of the short-dated Treasuries they bought from the Fed. Primary dealers have to take part in Fed operations and need to raise money for those purchases.
Consequently, the dealers' need to finance their growing holdings of Treasuries has driven up their borrowing costs.
"As their balance sheets have ballooned, their funding rate has risen," said Bret Barker, portfolio manager at TCW in Los Angeles, which manages $128 billion.
If the Fed extends Operation Twist, dealers will likely have to absorb more Treasuries and borrow more to fund them, adding to their expenses.
"That risks their funding rate going up further," Barker said.
As of June 6, U.S. primary dealers held a combined $110 billion in Treasury bills plus regular and inflation government securities that mature in three years or less. Back in October, their net holdings of these securities were close to nil, according to New York Fed data.
In the meantime, their holdings of Treasuries that mature in six years and longer were $12 billion in early June, down slightly from $15 billion back in October.
During this period, the overnight interest rate on repurchase agreements, a key source of funding for Wall Street and others, has at times almost tripled.
The overnight rate on repos backed by Treasuries that dealers pledge as collateral to banks, money market funds and other cash lenders was about 0.10 percent early last October. It was about 0.18 percent early Tuesday after jumping to 0.28 percent late last week.
Money funds and other cash investors have refrained from raising their repo exposure due to the relative low yield on repos and possible downgrades of Wall Street banks by Moody's Investors Service before the end of June, analysts said.
INTRADAY CREDIT FEE RISE
One factor that some market participants blamed for high repo rates is BNY Mellon Corp (BK.N) raising its fee on intraday loans that back Treasuries trades.
BNY Mellon and JPMorgan Chase (JPM.N) clear the majority of Treasuries trades each day. They extend intraday credit until buyers come up with the cash to pay for the bonds.
A Wall Street firm pays the clearing banks for the loans which could last a fraction of a second to several hours. The firm does not use the daylight overdraft if it has enough cash in its account with the clearing bank.
This type of short-term credit is comparable to a bank's overdraft protection on a checking account.
On May 1, BNY Mellon increased its fee on its intraday credit or daylight overdraft by 0.06 percentage point to clear Treasuries transactions, BNY Mellon spokesman Kevin Heine said.
"That's an increase in cost given where rates are," said Thomas Roth, executive director of U.S. government bond trading at Mitsubishi UFJ Securities USA in New York.
The increase could make it unattractive for dealers to seek intraday financing for their Treasuries holdings, analysts said.
Some traders, however, downplayed the fee increase as miniscule and attributed the elevated borrowing rate primarily on the tremendous spike in short-term Treasuries that dealers are now holding as a result of Operation Twist.
"That has nothing to do with your funding," Raymond Gilmartin, head of repo trading with the Bank of Nova Scotia in New York, said of BNY's intraday fee increase.
A JPMorgan spokewoman said the bank had not increased its daylight overdraft fee on Treasuries trade.
SYSTEMIC RISK OF INTRADAY CREDIT
BNY Mellon's decision to raise its intraday credit fee is part of a broader industry move since the 2007-2009 global credit crisis. Urged by regulators, the industry has been trying to safeguard the financial system from the kind of credit squeeze that accompanied the collapse of Bear Stearns and Lehman Brothers in 2008.
The Tri-Party Repo Infrastructure Reform Task Force, a Wall Street group sponsored by the Fed, has cited an over-reliance on intraday loans in general and has said reducing them would protect the system from wider losses in the event of market disruption. The task force was created in 2009 to lessen systemic risk to the market for dealer financing.
BNY Mellon and JPMorgan also clear tri-party repos and make intraday loans on them.
"We are working hard to implement the recommendations from the Task Force to achieve the practical elimination of intra-day credit. The increase for daylight overdraft is consistent with that goal," BNY Mellon spokesman Heine said.
Heine did not offer details on how the increase affected the fee structures for various customers.
(Reporting by Richard Leong; Editing by Chizu Nomiyama)