By an interesting happenstance of timing, Barclays and the Royal Bank of Scotland have announced the establishment of $30 billion of facilities between them from the Federal Reserve. The Fed approved this move 10 days ago but it came to light only over the weekend. Both banks said these applications were unrelated to the SIV rescue plan led by Citigroup, JP Morgan, and Bank of America. Interestingly, RBS said the Fed is encouraging major banks to put this sort of facility in place. That is not a cheery bit of news.
The mechanism was that the Fed agreed to relax the restrictions on the amount the banks could lend to their US broker/dealer affiliates. The central bank approved similar exemptions from section 23A of the Federal Reserve Act and the Board’s Regulation W for Citigroup, JP Morgan, Bank of America, and Deustche Bank. Those regulations restrict the amount of “covered transactions” to any one affiliate to 10% of the bank’s capital stock plus surplus, and to all affiliates in total to 20%.
For fans of technical details, each bank got a letter setting forth the waivers. The banks used the similar language in their petitions. From the Fed’s August 20 letter to Citigroup:
Bank proposes to extend credit to market participants in need of short-term liquidity to finance their holdings of certain mortgages and related assets. For operational reasons, Bank proposed to channel these transactions through the Affiliated Broker-Dealer.
The laundry list of intended transactions differs slightly: on August 20, Bank of America and JP Morgan received approval for “certain mortgage loans and highly rated mortgage-backed and other asset backed securities.” On September 12, Deutsche got a go-ahead for a longer laundry list, including “commercial mortgage loans, consumer and commercial loans, equipment financings, and other related assets, as well as commercial paper, asset backed securities, and otehr structured products.” Can we throw in the kitchen sink? Barclays’ language, from the October 11 Fed letter, was not revealing (securities and certain other assets”): the language in RBS;s letter was similar to but not quite as encompassing as the Deutsche version (no equipment finance, consumer or commercial loans).
It is hard to tell how much the differences in requests to the Fed (the letters no doubt track the banks’ petitions) come from differences in drafting approaches of their lawyers versus their plans for the use of these waivers. Anyone who has any insight is encouraged to speak up.
Nevertheless, Michael Shedlock, when the first waivers were granted back in August, noted that the approvals were at odds with recommendations made with respect to Reg W waivers by member banks. From the Federal Reserve Bank of Chicago:
Broker/dealers actively use matrix pricing to validate the price of a fixed-income securities portfolio for SEC reporting and capital allocation purposes. In fact, matrix pricing is an accepted pricing convention for most fixed-income securities. Perhaps a distinction needs to be made between matrix pricing and idiosyncratic internal pricing models. In its simplest form, matrix pricing involves comparison of a security to other securities of similar credit risk profile and tenor to determine an appropriate spread to a reference Treasury security. Simple non-complex bond math is then applied to calculate a price. These spreads are tracked and disseminated through a number of widely used independent pricing sources
(Bloomberg, Reuters, etc.). In contrast, internal models are used to price more complex instruments that often involve imbedded optionality, contingent cash flows, or other subjective pricing assumptions. As a result, common sense warrants limiting matrix pricing for the (d)(6) exemption to relatively “plain vanilla” transactions such as investment-grade corporate bonds and commercial paper. This would effectively exclude most structured notes and mortgage-backed securities where the ultimate price is highly dependent on prepayment and rate volatility assumptions. (emphasis ours)
The story in the Financial Times was not able to give much insight into the planned uses of this newly-acquired freedom. The positioning it that, as before, these are contingency plans:
Barclays and Royal Bank of Scotland have followed other international banks by arranging $30bn of facilities from the US Federal Reserve that could be used by customers hit by the credit squeeze.
The banks said it was a back-up in case clients needed to borrow money against assets including mortgage-backed securities…
The Fed has given Barclays and RBS permission to borrow up to $20bn and $10bn respectively.
The facility would be used to cover the banks’ extension of credit to clients “in need of short-term liquidity to finance their holdings of securities and certain other assets”, the Fed said in letters to the banks….
Some investment vehicles are struggling to finance holdings of mortgage-backed securities through the issue of commercial paper and a group of US banks are putting together a $75bn superfund to buy some of their assets.
Barclays and RBS have not been involved in the detailed discussions of this plan and these facilities are unrelated.
RBS said: “Major banks such as ourselves and Citigroup and JPMorgan are encouraged by the Fed to have this kind of facility in place.”
People close to the banks said neither had any current intention of using the facilities.
Most expansive RegW and 23a exemptions stated purposes for RBS and Barclays:
… “to extend credit to market participants in need of short-term liquidity to finance their holdings of certain
residential and commercial mortgage loans and mortgage-backed securities, commercial paper and other structured products… the transactions between Affiliated Broker Dealer… and unaffiliated market participants…. will take the form of either reverse repurchase agreements or securites borrowing transactions “securities fiancing transactions””.
-daily margin maintenance
-SFT with affiliated must be accompanied by SFT with unaffiliated market participant on same terms
-collection even in case of bankcruptcy
-available for SFTs initiated while special discount window lending facility (SDWLF) is available
-For SFTs whose term exceeds SDWLF life, transactions can be held to maturity
All have public interest rationale
“public benefits…. enable Bank to provide substantial liquidity to the markets for the Assets…….Affiliated Broker-Deaer as its conduit to convey funds to market participants, the exemption would allow….. liquidity in the most rapid and cost effective manner”
Similar prior exemptions related to securities financing from Wachovia and Citibank, but the latest five, from Aug 20th on, have public interest rationale and the relationship to the SDWLF.
Note that not using them undermines the pubic interest rationale.