Top dealers to Fed: Flow of credit continues to slow

Credit in key areas of the repurchase market continued to tighten in the fourth quarter, according to the Federal Reserve’s quarterly survey of senior credit managers at 20 leading Wall Street dealers.

The finding furthers a trend that the Fed reseachers first spotted in the July through September period, and it confirms other published reports of unease in U.S., U.K. and European credit markets in the second half of 2011.

It suggests that the flow of credit is slowly choking on one of the most important international financing markets.

From the report:

Broadly consistent with the September responses, dealers reported a further  worsening in the liquidity and functioning of the underlying asset markets covered by the survey.

In particular, net fractions of respondents ranging between one-third and one-half indicated that liquidity and functioning in these markets had deteriorated over the past three months. …

This tightening was especially evident for the financing of corporate bonds (both high grade and high yield), agency and non-agency residential mortgage-backed securities (RMBS), and commercial mortgage-backed securities.

The Fed report is the only opportunity the general public has to hear directly from high-level but hands-on people deep inside the repo and securities lending* markets, which supply a big part of the credit in the U.S. and triggered the financial crisis in 2007-2008.

The report analyzes how easy or hard it is for dealers’ clients to get credit when they post various types of collateral in these transactions.

This matters to all Americans because, for example, if dealers’ customers can’t get loans using mortgage-backed securities as collateral, then they may not have the money to make more home loans. If they can’t get loans using corporate bonds as collateral, they may not have the money to make more business loans.

The report is a rare look inside so-called shadow banking, where deposits and loans are made outside the traditional banking system.

Among other news in the survey released December 29:

-Dealers said a growing number of their clients want to be protected from lenders’ margin calls by putting a “margin lock” provision in their contract.

Margin calls were a key cause of the financial crisis of 2008, as spooked repo lenders suddenly demanded more collateral or repayment, and borrowers who couldn’t comply faced insolvency. It appears some borrowers are fighting back.

A margin lock is defined for the purpose of this survey as a provision that insulates clients over some period of time from increases in margin requirements beyond those imposed by central counterparties.

About one-third of respondents reported that these provisions had been a significant and widespread topic of discussion with potential new clients and with current clients renegotiating agreements, while about one-third indicated that the issue had arisen in some discussions with clients.

Clients most aggressively seeking margin locks included hedge funds, mutual funds, exchange-traded funds, pension plans, endowments, and some investment advisors.

-Dealers said borrowers are trying to get longer-term loans, another sign they’re seeking safety.

… demand for term funding with a maturity greater than 30 days increased for all types of securities.

-Dealers said they’re tightening up on the credit they extend to some clients. This was mainly because of concerns about the financial strength of other financial institutions and increased strains in the global financial markets, the Fed said.

Responses to the December survey indicated a broad but moderate tightening of credit terms applicable to important classes of counterparties over the past three months. 80 percent of dealers reported having decreased limits for some specific counterparties.

The Fed survey is called the “Senior Credit Officer Opinion Survey on Dealer Financing Terms.” Surveyors track whether leverage and credit availability are rising or falling in the “securities financing” sector, which is mainly repo and securities lending. 

The survey also reports on the over-the-counter derivatives market.

The current report compares November 2011 to September 2011.

Regulators gather the information by surveying senior credit officers at companies that handle almost all of the securities financing transactions in their industry and much of the derivatives trading, according to the Fed.

In the survey, regulators ask the credit officers to detail changes in their financing activities, including tolerance for risk, use of short- and longer-term credit, acceptance of various types of collateral, and relationships with counterparties.

Counterparties discussed in the Fed’s survey include broker-dealers, central clearinghouses, hedge funds, REITs, mutual funds, exchange-traded funds, pension plans, endowments, insurance companies, separately managed accounts established with investment advisers, and nonfinancial corporations.

Collateral discussed include high-grade corporate bonds, high-yield corporate bonds (junk bonds), stocks, residential and commercial mortgage-backed securities including those that are insured by Fannie Mae or Freddie Mac and those that are not, and asset-backed securities backed by consumer loans like credit cards and automobiles.

Wonder who does this survey?

This document was prepared by Michael Gordy, Division of Research and Statistics, Board of Governors of the Federal Reserve System. Assistance in developing and administering the survey was provided by staff members in the Statistics Function and the Markets Group at the Federal Reserve Bank of New York.


*Securities lending, a smaller cousin to the repo market, is where asset managers lend securities, mainly stocks, in return for cash or other securities. Companies borrow securities mostly for short selling but also to use as collateral for loans and for hedging derivatives.


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