Credit Suisse Group AG, Bank of America Corp. and JPMorgan Chase & Co. lead borrowers tapping the largest prime money-market funds through repurchase agreements that finance about $20 billion of securitized debt, according to Fitch Ratings.
The three dealers provided 72 percent of the structured-finance securities without government backing used as collateral for so-called repo loans by the 10-biggest funds, Fitch said today in a report, citing data through Dec. 31. The median “haircut,” or discount to the value of the bonds, mainly notes tied to U.S. mortgages issued before the housing crisis, was about 8 percent, the ratings firm said. That translates into about $18.4 billion of total borrowing.
The ability to fund holdings of securitized debt with repo dried up in 2008 and 2009, exacerbating the worst financial crisis since the Great Depression. The typically short-term loans are now often backed by small, speculative-grade mortgage securities trading at discounts, with a median value of $800,000, Fitch said.
“The use of repo to fund these less liquid assets creates potential risks for both repo borrowers and the underlying asset class,” New York-based Fitch analysts Martin Hansen, Robert Grossman and Kevin D’Albert wrote in the report. “Repo funding for structured finance assets largely evaporated at the height of the U.S. credit crisis, a loss of liquidity that likely contributed to the steep valuation declines.”
Dealers can use repo to finance their inventories or to fund their own loans to clients. Securities are sold to a lender with an agreement by the borrower to buy them back later. Haircuts protect lenders against price declines in the collateral, in the event the borrower defaults.
Credit Suisse provided 32 percent of the structured-finance collateral for repo loans from the 10 money market funds, according to the Fitch analysts, who cited fund disclosures and also referenced data from the Federal Reserve Bank of New York. Bank of America offered 22 percent, while JPMorgan was the counterparty on 18 percent, according to the report.
Drew Benson, a spokesman for Zurich-based Credit Suisse, Zia Ahmed, a spokesman for Charlotte, North Carolina-based Bank of America, and Justin Perras, a spokesman for New York-based JPMorgan, declined to immediately comment on the report.
The total amount of structured-finance repo in the main, so-called triparty portion of the market mostly held steady in the past two years at about $75 billion, according to Fitch calculations based on Fed data. The total was understated by excluding so-called collateralized debt obligations, the ratings company said. The figure is about 10 times daily trading volumes, Fitch said.
Wall Street dealers in a quarterly survey reported increased demand to finance purchases of mortgage securities and a rise in the risk appetite of hedge funds in the three months through February, the Fed said in a report on April 4.
The median yield on structured-finance repo provided by the money-market funds was 0.63 percentage point as of Dec. 31, compared with 0.17 percentage point for Treasury-backed repo, according to the Fitch report. Residential-mortgage bonds without government backing accounted for 74 percent of the collateral, while CDOs represented an additional 9 percent, based on disclosures covering a subset, the firm said.