Basic HTML Version
20
|
Opportunities and Challenges for Hedge Funds in the Coming Era of Optimization
Asset Owners De-Emphasize GC
and Focus on Specials
Many asset owners interviewed for the survey
indicated that they now mandate lenders to achieve
a minimum lending spread on their equities GC—most
frequently cited as about 20 to 25 basis points. This
spread is seen as sufficiently large to warrant moving
supply out of custody and cover the operational risks
of having that asset out on loan. This is a tough
threshold to meet, however, particularly in today’s
low interest rate environment. A significant portion
of the existing pool of equities GC assets is therefore
sitting in custody.
Yet, the economics on most asset owner’s portfolios
are little changed. This is because lending has been
focused on the specials portion of the portfolio and,
though the pool of that supply is much smaller, the
loans command much larger spreads. RMA figures
confirm this trend.
In aggregate across the equities lending market, yield
on the lending portfolio (measured by the average
weighted cash spread above the risk-free rate and the
average non-cash premium together) amounted to 66
basis points in 2007, but was up to 78 basis points in
2013 according to the RMA.
The value of the lending portfolio is now paramount
in terms of understanding the success of the overall
program. Utilization is no longer a valid measure in
the new market dynamics as there is a deliberate
decision being made to reduce usage of GC. This is
illustrated in Chart 12.
The impact of reduced usage of GC in the lending pool
is quite dramatic when viewed on a time series basis.
Markit in their Q1 2014 Securities Finance Review
noted that utilization levels across all asset classes
hovered in the 10%-11% range by the end of 2013,
down from 13% back in 2010 and significantly below
utilization rates of just over 20% in 2007-2008. Yet,
the value of that supply in loan programs has been
climbing steadily since the early-2009 market trough,
finally equaling pre-GFC levels by the end of 2013.
This is illustrated in Chart 13.
Thus, on the surface, the intrinsic lending approach
seems to be succeeding for those asset owners in
these lending programs—despite eroding utilization,
the overall value of assets out on loan is up and
poised to potentially grow beyond the highs noted
pre-GFC. Yet, these figures mask an uncomfortable
dynamic. Declines in the utilization of lendable supply
are not occurring against a stable pool. The amount
of lendable supply is increasing sharply and more and
more assets are being left unutilized.
Total lendable supplies as of Q2 2014 were $15.5
trillion according to Markit, with only $1.58 trillion out
on loan. This left the amount of unutilized lendable
supply at $13.9 trillion. This marks an 82% increase
from the $7.6 trillion pool of unutilized supply at
the end of 2008 and a 24% increase from the $11.2
trillion pool noted at the end of 2011. These figures
are illustrated in Chart 14.
“ Prior to 2007, it was all about utilization and how much of my
portfolio can you get out. The thought was that I’d rather make 5
basis points than have my collateral sit in a box. This was especially
true on the fixed income side,” — Agent Lender
“ The way an agent describes their program to their clients is also
important. The metrics in the past have been about utilization—
assets out the door. This is the opposite of lending for value, not
volume. We’re looking at balances too frequently and not quality,”
— Industry Trade Organization
Source: Citi Business Advisory Services
Chart 12: Lending Approach Post-Crisis
0%
Minimum
Value of Lending Portfolio
Maximum
100%
Minimum Threshold
For Lending of
General Collateral
Focus is on
Only Those Portions
of Portfolio with
Intrinsic Value
Specials
Usage
Goal
Pre-
Crisis
Return
Goal
Lent GC
Under
Threshold
GC is Left
In Custody
Utilization of Portfolio Assets
No Longer Seen
as Measure of Success