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As a result, interest in lending general collateral (GC)
began to decline as the spread these assets could
command was not worth the operational risks without
the incentive of generating large amounts of cash
to reinvest. Many asset owners began to impose
minimum lending targets of ~20 basis points on their
GC equity supply—a figure that is difficult to obtain in
the current low rate environment.
More emphasis was placed on the specials held in the
asset owner’s portfolio. By their nature, there will be
a lower volume of these trades done in the market,
but at a higher value. This has shifted the measure
of the effectiveness of a lender’s program from their
utilization of the asset owner’s supply to the overall
value of their supplies out on loan.
Indeed, even with substantially lower utilization
across the pool of lendable supply, the value of loan
programs is nearly back to pre-GFC levels, although
the split between the economics of lending equities
versus lending bonds is clearly diverging.
Maximum Utilization Approach to
Lending Loses Appeal
There are broadly two types of securities that
comprise lending portfolios. General collateral
(GC) has traditionally made up the bulk of lending
portfolios, as these securities are uniformly high
quality, liquid and fungible for a standard rate. This
contrasts with a smaller set of special securities that
need to be individually valued due to their unique
credit rating or limited supply.
In the years prior to the GFC, asset owners looked to
loan out as much of their supply as possible across
their pools of both general collateral and specials.
As noted back in Chart 6, returns being generated
in lending programs in this period came from both
the loan and the collateral investment. Having more
supply out on loan meant having more cash collateral
coming into the program, which in turn meant that
there was a larger pool to reinvest to generate yield.
Though the spread on the GC portion of the loan
portfolio may have been significantly smaller than
the spreads attained for the specials, GC securities
could be lent in large volumes. The total return
on the lending portion of the portfolio was then a
blended rate derived from high volume, low spread
GC transactions and low volume, high spread specials.
This is illustrated in Chart 11.
The risk/reward trade-off of lending large amounts of
GC worked in this model because the cash collateral
proceeds from those loans could be reinvested into
potentially much more profitable vehicles. That is
no longer the case, as discussed previously. With
cash reinvestments generating so little return, the
operational and potential reputational risks of having
large amounts of GC out on loan are becoming
more concerning.
Section II: Intrinsic Lending Gains Prominence &
Shifts Market Dynamics
Source: Citi Business Advisory Services
Chart 11: Lending Approach Pre-Crisis
Usage
Goal
0%
Minimum
Value of Lending Portfolio
Maximum
100%
Utilization of Portfolio Assets
Higher Utilization of
Portfolio Assets Supported
Increased Returns
Value of Lending
Portfolio Reflected
Blended Spreads
Across GC & Specials
General
Collateral
Specials
Usage
Goal
Return
Goal
With the cash collateral reinvestment portion of their portfolio now generating far less return
than in the pre-GFC period, many asset owners began to rethink the structure of their lending
program. More emphasis was placed on the intrinsic value of the lending supply itself, not on the
combined value of both the lending supply and the collateral reinvestment.