Securities Lending Today

To Underwrite or To Not Underwrite ?

The announcement by the UK regulators last week that firms won’t be able to protect against potential losses by shorting stocks underwriters and sub-underwriters is potentially a costly new restriction.  I understand the concern that firms are receiving underwriting fees to undertake the exercise and that there is a possibility of undermining the sale of the stock, but surely firms must be able to hedge against risk.   In fact, if firms can’t hedge their potential risk, why undertake the transaction in the first place?  A Bloomberg story on the subject carries the quote:

“Laying off risk through short-selling can push a stock price lower and can be damaging to the client,” said Tom Troubridge, head of the capital-markets group at PwC in London.  

Maybe there is a reason the stock price should be lower in the first place?  Nothing is free, and if there is a greater risk of loss when underwriting an issue, it will be reflected somewhere – higher fees or lower target prices or elsewhere.  I think this is another example, like the ban on short selling, that looks good on paper to the public, but practically has a negative impact on the markets overall.

I am up late every Sunday night into Monday morning so that I can get my fix of American football, so it’s not my favourite day for maths.  Hence I was perplexed when reading Guido Fawkes’ blog this morning that was looking for an explanation of the Bank Bail-Out in the UK.  Check out this article, and if you can explain how the government is expecting the numbers to work out, please let me know. 

Sorry to have my first post of the week predict bad news, but it can’t be helped.  My man Finbar Taggit is predicting worse news on the job front this week than we had last week.  

And let's share in the emotions of Bill Fleckenstein who is leaving the hedge fund world in words that were picked up by CalculatedRisk:

"on a personal note, I no longer want to run a short-only hedge fund, as it is very stressful, nerve-wracking and generally not very much fun." 

Good luck this week:  I’m a Stock Lender – Get me out of here!

Finally Friday!

No one looks forward to the first week of December.  Based on what we’ve seen this week, you can hardly blame them.

By the time you have read this, the US non-farm payroll data will have been released.  Many expect this to be the worst numbers in 30 years.  [UPDATE:  533,000 job losses over the previous month, the highest number since 1974] That will follow in a week where Reuters reported that 50,000 job losses were announced this week across the financial sector globally.

The shareholders of both Bank of America and Merrill Lynch will be voting today to approve the takeover.  If approved, the new entity is unlikely to be announcing a new hiring spree. 

Central Bankers have been cutting interest rates around the world this week, with the market betting in favour of another 75 bp drop in rates in the US on the 16th.  I feel bad for the savers of the world, but since my mortgage is due for renewal next month, I am not unhappy with the cuts myself. 

Hedge fund performance numbers for November have been released by Hedge Fund Research.  Their HFRX Global Hedge Fund Index dropped another 3.04% last month, with the accumulated loss for the year standing at 22.3%.  Merger arbitrage funds picked up 1.57% last month, with the other winners being macro funds (+1.48% for the month) and equity market neutral funds shooting up a massive 0.69%.

With numbers like these, it’s no wonder that the redemptions have been coming thick and fast in the second half of the year.  But now we are getting down to the short strokes on the hedgies coming up with the cash.  Many have had to turn to their prime brokers to look at ways of funding the redemptions.  The only problem is that the huge drops in assets under management due to redemptions and performance issues could activate triggers in their lending documentation.  The FT highlights the issue today.  There is a reason why the PB's had the clauses in place in the first instance and it will be interesting to see how this all plays out.  I don't know any firm that is looking to increase the risk profile of their business.

The predictions for 2009 have started.  Goldman Sachs’ outlook for 2009 describes continued short-term risks follow by a transition to a sustained and sharp recovery.  Let’s hope they are right.

Follow up on AllAboutAlpha.com Article

One of Stock Lending Today's avid readers passed on an article written by Christopher Holt of AllAboutAlpha.com entitled "Securities Lending starting to dry up a little?"  

Mr. Holt brings together a number of strands quite nicely in his article, and I wanted to expand on these points a little bit further.  I suggest you take a few minutes and read it, as I am making additional points and comments based on his article rather than starting this post from scratch.

He looks at a number of issues in securities lending at the moment:  Supply/demand, the Watson report and cash reinvestments.   I have taken a number of the comments made by the contributing reader and added some of my own.  Probably all the good comments are his and the ones you disagree with are mine.

In addition to the points raised, demand has also been impacted by a few other factors.  Hedge funds have been closing out both long and short positions for some time in order to fund redemptions.   As well as hedge funds, investment bank prop traders have been loathe to take on new positions and have been in "December lock-down" for some time now.  For many, 2008 was a write-off and they have not been keen on risking further losses, rather they are holding fire until we get into 2009.  I also continue with my assertion that as stock market prices continue to drop, the risk reward scenario for a directional short changes and becomes less attractive.

Regarding the reduction of supply, I have questions about the “quality” of the assets that have been pulled from lending programs by institutions.  I have yet to hear too many lamentations about the disappearance of liquid, widely available “general collateral” assets from the global lending pool.  Inevitably there has been a diminution of some assets that are in demand and can’t easily be replaced, but by and large the stocks that have gone have been substituted without too much concern.

The Watson Wyatt report?  Don't get me started.  Refer to my previous blog on the subject instead.

The Pensions & Investments article referred to quotes a corporate pension fund executive as saying he was surprised at how much long dated paper was held in the collateral pool for his loans.  Surely people check their investments from time to time and cash collateral re-investment should have been the same.

In any case, as the reader points out:

“This for many will no doubt be a contentious view point but ABS and MBS were seen as good investments for many years and by the size of the market issuance this view was held by others not just Securities Lenders. Risk managers and investment professionals believed they were appropriate investments as did rating agencies who rated them AAA.”

Time will tell just how many of these investments actually default.  Until then, the real losers will be the ones who bought at previous “normal” market prices and have been forced to crystallise losses that are simply a result of selling distressed assets in an illiquid market. The real winners will be those who do the buying and can fund them until maturity.  

Chris makes reference to the joint statement issued by ISLA and other lending associations in September.  The letter from the various lending institutions came at a time of significant stress in the markets stemming from the Lehman default.  Indeed, there were several well-publicised withdrawals from lending in whole or in part by a number of institutions.  However, this has levelled off recently and I believe that the joint statement was an important and valuable move in stemming the tide.

Chris suggests an almost inevitable increase in the cost of borrowing stock,  Given that the need to maintain liquidity in cash reinvestment pools is currently skewing lending fees, it is difficult to necessarily come to the conclusion that the reduction in supply will result in higher intrinsic fees charged to borrowers.  We all watch this point with interest.

However, as Mr. Holt points out oh-so-accurately there is an awful lot of peddling going on under the waterline to keep the motion of the securities lending business going.  The only disagreement I have with him is that I prefer to think of securities lending as a swan, rather than a duck.

P.S.  Thanks to the contributor of the article!

Generous Offer from DataExplorers!

Help for those looking for work

One of the challenges for those who who have recently been made redundant from our industry and are seeking a return is the need to stay current with the market. Coffees and informal chats are helpful, but it is easy to lose touch with the business. The kind people at DataExplorers are offering some help. They have asked me to mention that securities lending professionals that have been recent casualties of the ongoing market turmoil may be able to get access to some of the DataExplorers market-leading data.

This aggregated and anonymous information should assist people in staying current with market trends. Access to the data is at the sole discretion of DataExplorers and if you are interested in seeing if you are able to get access, please contact support@dataexplorers.com or call +44 207 264 7600 (Europe) or +1 866 861 6171 (US) or (Asia).

Yesterday's video

Due to some bizarre restriction, the video on yesterday's blog didn't work.  Please revisit the link, it should work now.  Many apologies to those of you who wasted time trying to get it to load.  It's worth the visit, just make sure you watch it past the ad at the start!

Watson Wyatt

I have continued my crusade against the superficial scare mongering Watson Wyatt report that I mentioned last week.  The report continues to get coverage and I have been busily contacting the journalists that have given it time in order to put the report in perspective.  I have received more positive feedback on that blog than I have for any other post I have done.  Thanks for the many supportive comments.    I think we have to fight this report.  I met an institution yesterday who has been asked some questions within their own firm about the Watson report.  If you have any suggestions for further follow-up, please send me some details.

It's that season!

I am off to my first securities lending Christmas party of the season tonight.  You can tell times are tough when it takes until December to have your first party!  Have firms cut back, or is it just that I am less popular?  Answers on a post card please.

An Odd Day - Corrected Version!

Apologies to readers who couldn't get the video link to work.  Fixed now - Thanks for pointing it out CCD!

Where to turn next?

Unemployed and not certain where to turn?  Check out the video below from Wallstrip.com and maybe it will give you some ideas.  I have launched Zimmerhansl Consulting Services, but how about Zimmerhansl Consulting Services Bank ZCSB - I'm sure I could market this as a Swiss bank - don't you think?

WallStrip.com

Tax Relief on Stamp Duty in UK

I wasn't aware of this, but in the pre-budget report in the UK last week there was a provision stuck in there for relief from stamp duty on transactions whereby a stock lender is disposing of collateral to acquire replacement shares as a result of a borrower default.  It pains me to say so, but this is a helpful and sensible provision from the government.  What an odd day - I'm saying something nice about Darling Darling.

Analysts cut Earnings Expectations

Brokerage analysts have been cutting earnings expectations on US investment banks (is there such a thing any more?).  Bloomberg, amongst others have picked up the story about reduced numbers for the fourth quarter which ended at the weekend.  Dramatically slashed expectations for Prime Brokerage numbers are a key driver for this reduced income, highlighted recently by Morgan Stanley itself which flagged a potential 45-55% reduction in anticipated PB revenues for next year. 

P.S.  Following on from the video above, maybe the brokers should become bank holding companies.  Wait, they've already done that?