The Fed Senior Credit Officer Opinion Survey on Dealer Financing Terms: it's the special questions that count

Late last month the FRB released their quarterly Senior Credit Officer Opinion Survey on Dealer Financing Terms  (SCOOS). To be honest, reading the financing tea leaves based on survey responses is not terribly interesting. We have seen some subtle shifts in market attitudes show up in the survey, but rarely is it earth shattering. Many of the questions are of the “have you done _____ or would you prefer a sharp poke in the eye” genre. For example, these days would a credit manager admit to be paying less attention to concentrated credit exposure to dealers or acknowledge an ease in cure period terms with hedge funds? Most of the differences, both inter- and intra-survey feel like noise.  The interesting part is the “special” questions section. Interesting probably more that the Fed is asking than what the predictable answers are.

This survey included “special” questions:

— changes in risk appetite exhibited by different client types,

— a second special question that focused on efforts by clients to negotiate third-party custody of independent amounts (initial margin) and collateral, and

—  a final set of special questions regarding recent developments in securities lending

The survey showed little change in risk appetite of different client types since the start of 2012 (after a decline in 2011). Yawn.

The third-party custodian questions are a bit meatier. Two-thirds of dealers saw an increase in efforts to segregate collateral, with 2 of the 20 respondents reporting, “these efforts had increased considerably”. This dovetails into the adoption of Legally Separated Operationally Commingled (LSOC) by the CFTC. We wrote about that on March 6th. A link is here.

The knock-on effect of collateral segregation, beyond the obvious isolation from dealer insolvency (read: Lehman (Europe) & MF Global), is that more collateral will sit dead in accounts. Re-hypothecation may have become a dirty word, but it is a critical lubricant in the financial world. Taking it way will impact liquidity and not in a nice way. Re-read our post from January 2012 here.

Having said that, tri-party collateral infrastructure is in a great position to facilitate collateral segregation and that looks like a nice business opportunity for them.

On the securities lending side, there were a couple things worth mentioning as possible hints of the future. “…Of note, a modest fraction of dealers reported that the share of their collateral posted pursuant to securities borrowed that consisted of securities rather than cash had increased somewhat over the past six months…” (3 of 19 respondents) While cash is still the overwhelming favorite collateral, securities (as collateral) appear to be getting some traction. In a zero rate environment still haunted the collateral reinvestment debacle, it should not be a surprise. Is the collateral transformation trade also a driver of securities as collateral? We are reminded that collateral transformation trades are typically long term deals vs. the short term world that sec lending inhabits and the nasty maturity mismatch that could result.

“…In response to a question about changes over the past six months in the volume of securities borrowed by source type, about one-fifth of respondents indicated that the volume of securities borrowed from securities lending programs administered by custodian banks or other agents had decreased somewhat…” While 80% of the respondents said that securities lenders were the largest source, by volume, of borrowed securities, it is worth noting that the sec lenders don’t have a lock on supply.

A link to the FRB SCOOS report is here.

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