February 11, 2014 / 12:31 PM / 6 years ago

RPT-Fitch: Tri-party drops again but equity repos at record high

Feb 11 (Reuters) - (The following statement was released by the rating agency)

As policy risks weigh on the US tri-party repo market, total collateral has continued to shrink to USD1.55trn on 10 January 2014 from USD1.61trn in December 2013, Fitch Ratings says. But contrary to this broader decline, repos backed by equities have increased to a record high. The rise in equity repo, coupled with the relative stability in repos backed by structured finance and corporate bonds, is notable given policymakers’ concerns about “fire-sale” risks. In a scenario of stronger risk aversion, repo lenders, including money market funds and dealer banks, might tighten financing terms and availability, affecting both repo borrowers and the value and liquidity of the underlying assets funded through these markets. “Fire-sale” risks could affect all forms of repo collateral but are particularly acute for asset classes that are potentially more volatile or less liquid than benchmark securities such as US Treasuries.

The sharp 40% yoy increase in equity repos takes the outstanding volume to USD149bn or almost 10% of all tri-party repo collateral, according to recent figures from the Federal Reserve Bank of New York (FRBNY). This is the highest level since the data series started in May 2010, with growth accelerating in the month to 10 January 2014 (up 11%).

In comparison, repos backed by US Treasury and agency MBS securities continued to decline, as these more “rate-sensitive” forms of collateral collectively fell by about USD59bn over the past month and by more than USD350bn since January 2013. The shift to riskier forms of repo collateral partly reflects continuing low yields. For example, as of end-August 2013, repos backed by equities in the tri-party market yielded 35bp, compared with about 11bp yield on agency repos (see linked report).

In a study published in May 2013, FRBNY estimated that USD500m of equity collateral or 0.34% of outstanding equity repo can be liquidated in one day without an adverse impact on market prices. This assumes normal market conditions taking into account historical daily turnover. Under stressed market conditions, most asset classes, including equities, could take longer to liquidate and therefore potential losses are likely to be even higher. Policymakers face a delicate balance between mitigating the potential for fire sales and the vital role of repos in providing liquidity and funding across a range of securities’ markets.

Interestingly, despite a near 50% increase in broad market equity levels since October 2011, the degree of leverage achievable through repo borrowing for equity collateral is unchanged. Median haircuts, a reflection of leverage within a repo transaction, remained stable at 8%. The potential frothiness in equity securities does not appear to have affected the margin that repo borrowers are required to provide to repo lenders.

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