Fed SCOOS survey results on collateral transformation and the end of TAG

In late December the Federal Reserve released their quarterly “Senior Credit Officer Opinion Survey on Dealer Financing Terms” (SCOOS) report. The interesting stuff are always the special questions. This report’s were focused on collateral transformation and the sunset of the FDIC’s Transaction Account Guarantee (TAG) program that provided unlimited insurance to non-interest bearing transaction accounts. We take a look at the results of the survey’s questions on collateral transformation and TAG.

“…Relative to the beginning of 2012, dealers indicated that the volume of collateral transformation transactions through which clients source and provide pristine collateral had remained basically unchanged on net…” In other words, not much volume is actually going through. We have heard this before: lots of talk, not a lot of action. This may change in 2013 and certainly the survey acknowledges that people are thinking about the topic. Looking at discussions about clients sourcing high quality collateral “…between about one-third and two-thirds of respondents reported frequent or at least some discussion of prospective transactions with all client types covered in the survey…” However the percentages of clients contemplating being the source of paper was lower (1/4 to ½ of respondents). Hedge funds and insurance companies were the most likely client types to be focused just on sourcing paper; other clients were more balanced on how they could source or provide paper.

Perhaps asking the securities lenders about transformation trades might have yielded more interesting results? They seem to be more the epicenter of this activity, especially the sourcing of CCP eligible paper. Nevertheless, activity remains muted overall. This seems consistent with our theory that small and medium sized firms, mostly investment managers, haven’t done the heavy lifting on collateral management and could be in for a big surprise on how complicated it could end up being.

On TAG, “…respondents were queried about the likelihood of reductions in the amount of deposits held at commercial banking institutions and, conditional on such reductions, about the likelihood of increased use of alternative cash management strategies…” While the responding dealers did not, by and large, see a need to reduce their deposits at commercial banks (80%), the answer was different when the question focused on what dealers thought their clients would do. “…About three-fourths of dealers anticipated reductions in deposits held at commercial banks by traditionally unlevered investors, such as insurance companies; mutual funds, ETFs, pension plans and endowments; and asset managers…” and “…Nearly two-thirds of respondents anticipated reductions of deposits held at commercial banks by nonfinancial corporations, with a couple of dealers suggesting significant reductions were likely…” Where will the money go? “…(survey participants expected) reallocating (of) deposits to other commercial banks or by increasing their use of repurchase agreements, money market funds, Treasury bills, and longer-dated Treasury securities or agency securities…” Not surprisingly, CP investments generally were expected to be left out of the mix.

TAG feels like it ended not with a bang but a whimper. Maybe as Treasurers get back to full speed in the New Year, this will change. Certainly the first hiccup at a prominent’ish bank will jolt people into action (not that we are wishing for that). We have written that the most similar risk profile to government guaranteed deposits would be to invest in short government paper or govie-backed repo. Eventually cash will flow that direction. But the path of least resistance may be pushing cash into money market funds and/or the large banks. All roads lead cash out of smaller institutions and that could be a problem to watch out for.

A link to the FRB SCOOS report is here.

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