Direct repo transactions had a major moment of publicity from the Wall Street Journal. “Repo Market Sees a Lending Shift as Rules Bite” by Katy Burne was a very good look at the market and participants doing live trades. Finadium data was cited as well. Our question is, following up from our January 2015 report on direct repo, has market sentiment shifted towards this type of transaction?
The WSJ story captured a good anecdote that supports the idea of market growth:
“Stephen Jones, who oversees about $4 billion of state money at the Commonwealth of Kentucky, said he completed his first direct repo trade in January, without using a large, bank-owned broker-dealer. The state is lending $123 million this month to a REIT called Invesco Mortgage Capital Inc., up from $50 million earlier.”
In January 2015 we published a research report on Direct repo, which we provided to the WSJ for their story. We noted that “The sheer notion of going Direct fills many market participants with dread; for example, a Direct transaction would make a state Treasurer exposed to a REIT or hedge fund looking to finance assets. Some institutions are prohibited from Direct transactions altogether due to a lack of credit rating from most collateral providers. However, for those institutions willing to consider this model, going Direct offers substantial opportunities in both supply and revenues.” The Kentucky quote is an exact example of a state taking advantage. REITs have been having a hard time getting financing; for them, states like Kentucky willing to get Direct are truly a great thing.
We wouldn’t necessary call this example Direct repo, which we define as being between end-users, but its still interesting:
Byron Boston, chief executive of Dynex Capital, a REIT, has been using a nonbank repo dealer called South Street Securities, which focuses exclusively on repos, for $500 million of repos daily. “Banks are picking and choosing their spots,” he said.
South Street runs a conduit book and is not investing cash as a money manager.
We remain optimistic about the prospects for Direct lending and borrowing but as we noted in January, most investors still have a substantial trust hurdle to get over before lending. The WSJ noted resistance at Northern Trust to engage in this market; they are not alone. The big trouble happens if a default occurs, and we have already seen an example where this has turned ugly.
The Direct market still has a long way to go before it gains mass acceptance. Still, a high profile article like this one is a real confidence boost for market participants and intermediaries like South Street and AVM. This could get exciting.
Finadium subscribers with Finadium.com logins can log in to access our January 2015 report, “Perspectives on Direct Borrowing and Lending”.