• Use of 'evergreen' repos helps meet needs to term out loans
  • Effort to meet mandate on liquidity ratios drives trend

Banks are stepping up their use of longer, extendable financing in the market for borrowing and lending securities amid a regulatory push to curtail dependence on short-term funding.

In the $1.6 trillion repurchase-agreement market, where banks procure temporary loans from investors looking to put cash to use, demand is growing for extendable, or “evergreen,” repos because of rules implemented to prevent another near-freeze of the financial system. Regulators have focused in part on reducing banks’ need to roll over funding so frequently -- as often daily in repos.

This corner of the repo world grew to about $25 billion in the second half of last year, from a negligible amount the prior two years, data from Markit Ltd. show. The business blossomed after the introduction in 2015 of a liquidity-coverage ratio that requires banks to hold enough high-quality liquid assets to cover cash flows for 30 days. The growth is set to continue, according to participants at the Bloomberg Investment Strategies Forum held Feb. 29.

Data from Markit
Data from Markit

“We are doing more of these non-standard repo trades,” Steven Meier, head of cash, currency and fixed income at State Street Global Advisors, which oversees $2.4 trillion, said at the event in New York. Most deals use non-Treasury debt as collateral, including corporate bonds, asset-backed securities and equities, he said.

Renewable Feature

Like typical repo agreements, extendable ones provide banks with a form of secured funding, with securities serving as collateral against cash loans. The main differences are that the extendable variety is renewable by mutual agreement between the two parties, and the deals also come with a lengthier notice period for ending the deal. Meier said he frequently uses extendable repos with a term of 120 days that can be renewed at the 90-day point if all parties agree.

In a 2013 Federal Reserve Bank of New York paper on risks in repos, researchers cited evergreen structures as a tool to reduce the chance that a solvent dealer would abruptly lose access to funding. During the credit crunch, the loss of repo funding contributed to the demise of Lehman Brothers Holdings Inc. and Bear Stearns Cos.

Extendable deals are useful to reduce banks’ risk, according to Bruce Tuckman, a finance professor at New York University’s Stern School of Business. Yet they aren’t fool-proof during a crisis if many have a similar 30-day term because of mandates concerning liquidity-coverage ratios.

Evergreen Risk

“These evergreens help you over the first bump in a crisis, but they won’t necessarily be around after that,” Tuckman, who’s also a senior fellow at research group Center for Financial Stability, said in an interview. “We saw that during the financial crisis, when evergreen funding dried up as nobody wanted to offer it anymore. Also, if everyone is doing 30- or 31-day evergreens, then if we get into a liquidity crunch all the lenders will refuse to extend and start the countdown at the same time.”

Use of the deals is still set to rise because of Basel III capital requirements such as the Net Stable Funding Ratio, according to Brian Smedley, head of macroeconomic and investment research at Guggenheim Partners LLC, which manages $240 billion. The NSFR requires banks to maintain stable funding relative to the composition of their assets to prevent liquidity from seizing.

“Dealers play a critical role in intermediating between cash lenders, who would prefer to have short-term collateralized investments, and cash borrowers, who are looking for longer-term financing,” Smedley said during the Bloomberg panel. “The problem dealers will encounter is that there are few cash lenders” looking to get involved in such agreements.

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