Two new updates shed light on two of the most obscure corners of the money markets, the repo or repurchase agreement market, and the securities lending cash reinvestment arena. Bank of America Merrill Lynch's Mark Cabana writes on the former, while J.P. Morgan Securities' Alex Roever writes on the latter. BofAML's latest "U.S. Rates Watch" brief, entitled, "MMF repo update: increased availability driven by overseas sources," reviews the surprisingly strong supply picture in the repo market, while JPM's latest "Short Term Market Outlook and Strategy" contains a "Securities Lenders Update." We excerpt from both briefs below.
BofA's Cabana tells us, "Each month the Office of Financial Research (OFR) releases data on money market fund (MMF) repo activity. We view this data as a good proxy for overall government securities repo activity, and use it to highlight trends and developments in the tri-party repo space with detail at the counterparty and fund level. The OFR measure of total repo ex-Fed is $681bn for Treasury and $295bn for Agency, which compares to FRBNY aggregate tri-party repo activity of $965bn for Treasury and $562bn for Agency MBS. If we include the Fed, the OFR data captures about 2/3 of total tri-party repo activity."
He explains, "OFR data shows overall repo activity contracting in 2013 with the proposal of supplementary leverage ratio (SLR) rules, bottoming in early 2015 with required public disclosure of SLR, and growing over the past 2 years. Treasury MMF repo has more than doubled since the start of 2016, from $310bn to $681bn, largely driven by increased flows into government funds through 2a-7 reform and greater repo availability from non-US counterparties. Inconsistent SLR application globally has led to variation in repo activity around quarter end, especially from euro area firms who report SLRs as a snapshot on the last day of the quarter."
The brief says, "Aggregate US GSIB repo activity has generally been stable since SLR began being phased in during 2015. However, since the end of 2016 repo activity has begun to vary around quarter end dates. The exact catalyst for quarter-end contraction is not clear, especially since US SLR is reported as a daily average. Two possible explanations may be (1) the annual GSIB surcharge which incentivizes firms to shrink balance sheets by the year-end snapshot date (2) internal firm requirements that seek to net down balance sheet on key reporting dates. According to OFR data there are varying degrees of quarter end contraction amongst US GSIBs, but is most concentrated at JP Morgan which accounts on average for nearly half of the swings since the end of 2016."
Cabana writes, "Since 2015, US repo activity by EU providers has seen an upward trend, with large swings in availability on quarter-end dates. Despite new rules on intermediate holding companies we do not expect European banks to contract their repo activity next year and believe repo activity at these firms will continue to grow. BNP remains the largest EU MMF repo counterparty in the US market and the largest overall MMF repo counterparty, comprising 15% of total MMF repo activity ex-Fed based on current data."
Finally, BofAML comments, "Repo provided by Japanese firms in the US market has been increasing since the start of 2016. Treasury repo has grown from $10.5 to $50.5bn and 46% of this growth has come from the current largest repo provider, Nomura. Since the start of 2015, repo provided by Canadian firms has also been increasing with Treasury repo growing from $12.5 to $68bn. Over 30% of this growth has come from the largest current Canadian repo provider, RBC. Other repo providers, Harvard, MetLife and Prudential, saw an increase in activity over 2015 and 2016, but plateaued in recent months at around $9.5bn. Sponsored MMF repo activity with the Fixed Income Clearing Corporation has also grown."
Regarding Securities Lending, JP Morgan's Roever explains, "Balances of cash reinvestment portfolios at securities lenders increased in the first half of this year, breaking away from the steady decline in assets under management over the past several years. Indeed, based on the most recent RMA (Risk Management Association) data, balances at securities lenders grew 13% during 1H17, from a post-crisis low of $582bn as of 4Q16 to $658bn as of 2Q17. The jump in balances was surprising, particularly in the context of a regulatory regime that seems to continue to favor securities as collateral."
He continues, "Furthermore, the increase year-to-date seems to suggest not only more cash collateral transactions but also more securities lending activity in general. A closer look at the amount of collateral lent over the course of this year shows an increase in the amount of US Treasuries and Corporates as well as European equities lent into the market. While the jump in equity lending transactions tends to be seasonal in nature with activity increasing during the second quarter of each year, the amount of US Treasuries lending transactions is the highest it has been since 2014."
The update says, "Anecdotally, we have heard that the increased activity has been driven by dealers being less constrained by their balance sheets as well as some smaller dealers entering the market. As dealers are getting more efficient in managing their balance sheets, they are able to take on larger GC flows, by borrowing GC collateral from securities lenders and lending it out in the tri-party market. The dealers earn the spread in between."
Roever writes, "On the portfolio management side, there has also been a notable shift in investment allocations. Recall that the implementation of MMF reform in 2H16 significantly weakened prime MMFs' demand for longer tenors, particularly in the 6m to 1y part of the curve. As that took place, yields cheapened so much such that it drew substantial interest from the non 2a-7 community, including securities lenders, as buyers of short-term bank debt. The RMA data shows evidence of this. A percentage of their floating rate instruments, the amount of floating rate CP increased from 9% in 4Q15 to 12% in 4Q16. And while floater spreads have narrowed this year, securities lenders continue to be a large supporter of this space, holding 18% of their floating rate instruments in CP as of 2Q17. By the same token, we've also seen a corresponding increase in the allocation of money market instruments that mature inside of 397 days."
Finally, he says, "Somewhat interestingly, there's also been an increase in the amount of fixed rate instruments held in the portfolios. YTD, the amount of fixed rate instruments rose from 10% in 4Q16 to 15% in 2Q17. Based on the holdings, it appears this came at the expense of repo and the "other" category as allocations to these sectors fell 3% and 2% YTD respectively. It's unclear what exactly prompted this shift. Our only guess is that it may be yield driven as the yield on fixed rate instruments (using Libor as a proxy) was substantially higher than repo during the first half of this year). Taken together, the uptick in cash reinvestment portfolio balances continues to underscore the amount of cash in the front-end of the fixed income markets. As dealers continue to optimize their balance sheets, we suspect securities lenders' demand for short duration products will remain, which all else equal will likely keep a lid on yields in short duration products even in a rising rate environment."
