By Richard Leong
NEW YORK, Oct 1 (Reuters) - Hedge funds, mortgage real estate investment trusts, small brokerages and other non-banks are most vulnerable if recent money market volatility results in a protracted increase in funding costs, Fitch Ratings said on Tuesday.
Banks, however, are less at risk, it added.
Overnight interest rates in the $2.2 trillion repurchase agreement, or repo, market soared in the last two weeks to their highest since the global credit crisis in 2008, prompting the Federal Reserve to intervene with hundreds of billions of dollars to restore order.
Analysts and officials pointed to hefty payments for corporate taxes and bond sales as exerting pressure on a market where a key source of liquidity - bank reserve levels - was already in short supply.
The surge in repo rates, which represent what firms charge for overnight loans in exchange for Treasuries and other securities as collateral, led the federal funds rate to break above the central bank’s target range on Sept. 17. The Fed has been injecting as much as $200 billion per day in temporary cash in an effort to hold down rates in the repo market, which Wall Street relies on to finance loans and trades.
While the latest disruption in the repo market did not materially hurt non-banks, Fitch said if the broader liquidity issues are not addressed, they may result in higher and more volatile borrowing costs.
“U.S. entities with a high reliance on repo funding, such as smaller broker dealers, mortgage REITs and certain hedge fund strategies, would face the most downside risk in the event of a prolonged spike in borrowing costs,” the rating agency said in a statement.
Banks are less-affected by swings in repo rates because they have backing from deposits, which are more stable, Fitch said.
Moreover, money market funds, pension funds and sovereign wealth funds earned a bit more income from the spike in repo rates. Fitch cited a money fund yielding 5.56% on Sept. 17.
The Fed is considering long-term fixes to avert future disruptions in the repo market. They include a standing repo facility and expansion of its balance sheet with the goal to increase bank reserves. (Reporting by Richard Leong; Editing by Dan Burns and Dan Grebler)