We noticed a discussion on Twitter between the Tracy Alloway (@tracyalloway) and Katy Burne (@ KatyBurne) about articles they have written on new players in the repo market. They also referred to an article written by Liz McCormick (@mccormickliz).
These three reporters have done a great job writing about repo. It should not be a surprise they are just a bit competitive with each other. Lets take a look at a couple of the articles that were tagged on Twitter.
Katy Burne’s “Repo Market Sees a Lending Shift as Rules Bite” appeared in the WSJ on April 7th. (Sorry behind the pay wall). We wrote a post on this “Direct repo hits the spotlight; are investors ready?” on April 9th. It is a premium content post available to Finadium subscribers only.
Burne says:
“…Lately, many big banks have retreated from the repo market following the adoption of costly new regulations. That has prompted many borrowers such as mortgage REITs, which borrow at low rates to amplify returns on their investments, to use new brokers that aren’t affected by the new rules or to borrow without a broker… The shift by REITs and others is driven in part by the retreat of large banks. Outstanding repo loans at the largest U.S. banks have declined by 28% over the past four years, according to Barclays PLC. The bank predicts an additional 20% decline…”
Burne mentions AVM, a non-bank broker in Boca Raton run by Jeff Kidwell as well as South Street Securities as non-bank players in the repo market.
We have seen where repo shops outside of the (now constrained) traditional big bank dealer group are taking advantage of opportunities. Some, like Wells, are big banks that have not been major players in repo but have balance sheet & capital headroom to grow. Amherst Pierpont Securities and South Street Securities are smaller broker/dealers running matched repo books as principal.
AVM puts together borrowers and lenders, and does not act as principal. For these repos to happen, each side to a trade must manage credit and risk management themselves. Most cash lenders need rated counterparties (pretty much ruling out hedge funds although maybe not if trades are centrally cleared) and that has favored the banks standing in the middle. It will be interesting to see how that changes as cash lenders increasingly run out of willing borrowers. The AVM guys have created a nice niche for themselves by figuring out who can deal with each other.
Burne also mentioned mREITs as active borrowers in repo. We have written about mREITs figuring out how to borrow, via repo, from Federal Home Loan Banks. See “The FHLBs are lending to REITs. Is this a good idea?” from June 25, 2014. Its not surprising mREITs are looking for cash sources outside of the capital constrained banks. But mREITs (or hedge funds, for that matter), who can be highly leveraged, facing money funds or insurance companies raises some questions in our mind.
There is a Liz McCormick June 10th article in Bloomberg “Money-Market Funds Finding New Repo Partners as Dealers Retreat”. McCormick brings up direct repo dealing between Federated and an insurance company.
“…Facing a shrinking pool of dealers in a key part of the $2.6 trillion money-fund industry, Deborah Cunningham did something last month she’s never done before in her 34 years at Federated Investors Inc. She arranged one of these trades directly with an insurance company…”
Federated can always go to the Fed with their cash, but as the article noted, that program is not permanent and has size limits. Depending on the Fed’s RRP is not a long-term solution.
McCormick brings up an important fact: if a fund invests primarily in CP, they will (in 2016) be required to report a floating NAV. This pushes cash back toward government repo, unfortunately just when the supply of repo (and cash T-bill) is shrinking.
Tracy Alloway’s (who is now at Bloomberg) article dates back to the May 29, 2014 FT “Big investors replace banks in $4.2tn repo market” (sorry, also behind the pay wall) made some of the same points:
“…Big investors, including hedge funds, mutual funds and real estate trusts, are replacing banks as the biggest users of the overnight funding market that played a key role in the financial crisis…”
Alloway gets into some good detail. She noted that REITs (we assume these are mREITs and not they guys who own office buildings) have increased repo borrowing from $90.4 billion in 2009 to $281 billion recently. She also said that closed end funds have gone from $2.74 billion at the end of 2007 to almost $8 billion now. (In all fairness, anything is going to look good when compared to 2007-09.) Indeed even senior tranches of CLOs are being repo’ed with Soc Gen and RBC being mentioned as actively lending cash again these securities. This sounds like investors and repo dealers both grabbing for yield by focusing on less than liquid instruments.
Alloway quoted Yuriy Layvand from Fitch:
“In the low interest rate environment, repo is very attractive…taking that money and investing it further out in the yield curve in fixed income assets.”
While we don’t doubt that low rates have pushed investors into a search for yield and that repo facilitates that objective, we have to say: we’ve seen this movie before.
It is clear that the repo markets are changing shape with big banks fading from the scene. Smaller dealers, often staffed by pros specializing in repo, can take up some of the slack but are not immune from capacity issues. Direct repo is creating opportunities to match counterparties outside of bank intermediation, but the credit analysis and infrastructure (think: margining and settlement) needs to be robust. DTCC efforts to widen out the GCF repo world to include money funds in a centrally cleared environment and Single Treasury Futures are on the horizon too. No single solution will dominate, but it is great to see the innovation.