Fitch has just published “Repos: A Deep Dive in the Collateral Pool”, a research paper focused on the tri-party repo market and less liquid collateral in particular. It is an update of a piece called “Repo Emerges from the Shadows”, released in February 2012. We commented on the original piece in two blog posts, “Déjà vu All Over Again: risky assets making a comeback in repo?” on February 6, 2012 and “Fed says not so fast to Fitch’s research saying riskier assets making a come back in repo” on March 1, 2012. The most recent work makes a number of interesting points and has some of the same issues of the earlier report.
The underlying data comes from trades done by the ten largest Prime Money Market funds, representing 7% of the overall tri-party funding market. The study focus is on riskier collateral – a $248 billion market – and their sample cover 16% ($40 billion). We wish the 7% number was higher and they addressed any potential skew by virtue of where their sample came from. Extrapolating from 7%, especially when that 7% looks pretty homogeneous, doesn’t sit well.
Of the $248 billion, $90 billion are “structured finance securities” and Fitch’s sample covers $21.2 billion. “…roughly 50% of this sample consists of legacy CDOs and subprime and Alt-A RMBS, much of which was originated by financial institutions that experienced severe distress related to their securitization and mortgage-related exposures during the U.S. credit crisis…” The message is that these are dodgy securities being financed. To make matters worse, the study quotes SIFMA stats on RMBS and ABS volumes ($6 billion per day). The ratio — $90 billion of structured assets being financed vs. trading volume of $6 billion – is not a good sign. The structured markets are in better shape than they once were, in part driven by a turn in the housing markets (presumably reducing defaults) but still, the point that it will take a long time to liquidate the paper in a stress environment (actually any environment) is well taken.
Fitch noted that 60% of the structured finance repos were executed with Credit Suisse, RBS, and BofA/Merrill. They reminded the readers that these firms have been active in the FRBNY’s Maiden Lane auctions of “crisis-era RMBS and CDOs” from Bear Stearns and AIG. Nice “connect the dots”. We wonder if those bonds which came out of the Fed are sitting in prop books and being funded as inventory (Mr. Volcker take note) or if the dealers funded the paper for their clients. Neither are ideal.
The rates broker/dealers are paying to fund the paper seem pretty high – 72bp on average versus 18bps on Treasury and agency collateral. Some of the difference may to attributable to repos on structured trades being longer than Treasuries or Agencies. Haircuts had gone up 7.6% as of the end of February 2012 vs. 5% in August 2011. Fitch also made an excellent point about the 7.6% haircuts being on the light side given the distressed nature of the collateral, the tendency for small trading pieces (53% of the pool were securities valued at $1 million or less), and the much wider bid-ask spreads in the structured finance cash markets (especially versus Treasuries).
The last point we thought was particularly interesting was about the changes in the top 10 dealers. Repo is a small club and business is typically highly concentrated in the top couple dealers. At the end of 2008, the top 5 dealers accounted for 61% of the trading in the sample. By February 2012 that number was down to 52%. This represents a couple trends: some broker/dealers are actually increasing their footprint and gaining market share (and with it the need to finance their inventory and clients). These would include Mizuho and RBC (at 5% and 4% market share respectively). Eurozone banks seemed to have retreated, with only Deutsche left in the top 10. Credit Suisse’s market share (12%) propelled them to the top slot in the report. CS is up from 5% in August 2011. They would have needed a 17% market share to capture the top spot in August 2011. In our opinion, the shuffle of the ranks predominately reflects pressure on capital & balance sheets making their way down to the repo businesses and, probably for the Euro-zone banks no longer very active, a push away from reliance on dollar funding.
There is more in the report and we urge you to read it. You’ll need to register on the Fitch web site to access the full report. Start by going here.