A Vision of the Future

Two events yesterday were important indicators of the coming year in securities lending.  They set the scene for the current issues and give us some insight as to the future.

Securities Services to the Rescue!

Goldman Sachs reported earning yesterday and announced its first quarterly loss since going public.  Despite a fourth quarter net loss of $2.12 billion, they still managed to post a profit of $2.32 billion for he year ending November 28.  An astounding result in this most “interesting” year.  Read more about the results here.

A special highlight was given to the Securities Services business which had net revenues of $3.42 billion for the year, 26% higher than 2007, which set the previous record.  Securities services includes the prime brokerage business.

On a call with analysts yesterday, Chief Financial Officer David Viniar gave some additional colour to the results.  He stated that  although customer balances declined from the third quarter - as did net revenue, which dropped 13% - but the type of services provided to its hedge fund customers were higher-margin.

All good so far.  Unfortunately Viniar is expecting less from 2009.  He points to investor redemptions in hedge funds driven by poor performance (and in my view unrealistic expectations), and indicates that assets under management at hedge funds will continue to fall next year.  While acknowledging that the higher-margin activity will insulate the division, he thinks that will only “somewhat offset” the impact of the reduced asset balances.

I also think that there has to be some impact from the more competitive landscape that now exists in the prime brokerage world of today.

AIG

Last week I read a story in SmartBrief.com which quoted the New York insurance superintendent as saying that insurance company securities lending programs needed to be reviewed.  He described the business as a "wonderfully smart use of assets but also [can leave companies] vulnerable to extreme stress"

Yesterday we read that AIG has sold $39.3 billion of mortgage backed assets to a new fund that has been established by the Fed – Maiden Lane II LLC.  The objective of the fund is to hold the assets that have caused significant losses to AIG in the past year.  There have been questions raised as to the price paid for the assets and whether they represent fair value.  I am not privy to any information at all as to the assets and how much has been paid, but major shareholder and former AIG CEO Hank Greenburg has questioned whether the assets have been sold to the fund at a fair price.  He alleges that the assets had been marked on AIG’s books at a much lower level than the price at which they were sold to the fund.  As a shareholder, why complain? 

In theory I think this is the perfect microcosm of the challenge facing the securities lending reinvestment market at the moment.  Doing asset marks-to-market often show values that don’t represent their true value.  In a fire-sale they wouldn’t represent the likely value at maturity or reflect the true potential for default.  However, a buyer that can fund and sit on the assets until maturity should be fine in the vast majority of cases.  That is the challenge faced by many lending programs at the moment.  Dealers want to borrow against non-cash collateral as it is more balance sheet friendly and doesn’t use up liquidity.  Lenders however need to keep cash pools liquid and deep in order to hold investments until maturity and generate the returns that almost surely will generate.  It will continue to be an uncomfortable road ahead …

P.S.  Many years ago, when one of my previous employers was making people redundant (when that was still unusual), they sent them to a separate location – on Maiden Lane.  At least this time around it will have a better ending.