Repo market dries up

Bear Stearns Cos.' financing crisis is shining the spotlight on an important market Wall Street banks, hedge funds and others rely on heavily for day-to-day cash needs. The $4.5 trillion securities repurchase, or "repo" market, enables financial institutions to obtain short-term, often overnight, funds by selling securities and agreeing to repurchase them a day or so later when the agreement matures. They get cash in return for the securities they temporarily exchange. In normal times, these loans are inexpensive and roll over easily. That's made them an increasingly important source of funding for many Wall Street firms, who sit on giant securities portfolios. As with other kinds of short-term financing recently, the money is drying up. Investors and financial institutions who lend in this market have become worried about losing money on securities used as collateral. Determined to protect themselves, they're pulling back from offering repo financing to each other. That has the potential to leave Wall Street in a chaotic scramble for cash -- a likely reason the Federal Reserve stepped in so quickly to aid Bear. In recent years, repo financing has accounted for a fifth to roughly a quarter of the total assets of the five top Wall Street dealers taken as a group, said analyst Brad Hintz of Sanford C. Bernstein & Co. He calls this market "the Achilles heel of the securities firms." Some firms have been trying to reduce their reliance on repo financing. Last year, for example Morgan Stanley reduced its repo financing to $162.8 billion, or 16% of total assets, at its Nov. 30 fiscal year end, from $267.6 billion, or 24% of total assets from a year earlier. Since mid-February, conditions in the repo market have tightened dramatically. That's made it harder not only for securities firms, but also for hedge funds and others to obtain or roll over such loans to finance their investments and trades. The development coincided with sharp price declines in some securities used as collateral for repo loans. "It was the market failure to roll repo -- securitized lending agreements -- that appears to have been Bear's problem," Jeffrey Rosenberg, Bank of America's head of credit strategy research, said in a report analyzing Bear's problem. In a conference call Friday, Bear Stearns chief financial officer Sam Molinaro said a liquidity crunch hit Bear because "we experienced pretty broad cash outflows from a number of different sources," including "the repo area" as well as outflows from the firm's prime brokerage clients and margin calls on derivative contracts. Bear may have been vulnerable to a repo a pullback because of worries about the value of this collateral. Mortgages represented a greater percentage of its total assets, Mr. Rosenberg said, at one-third, compared to 12% at Merrill Lynch & Co. and Goldman Sachs Group Inc., 13% at Morgan Stanley, and 29% at Lehman Brothers Holdings Inc. Some banks and lenders are choosing to make repo loans only in exchange for the safest debt securities, such as U.S. Treasury bonds, which have surged in value in recent weeks. Wall Street dealers and hedge funds that want to borrow against their holdings of mortgage securities have had to fork over significantly more collateral in order to get loans. Some banks and lenders are choosing to make repo loans only in exchange for the safest debt securities, such as U.S. Treasury bonds, which have surged in value in recent weeks. Wall Street dealers and hedge funds that want to borrow against their holdings of mortgage securities have had to fork over significantly more collateral in order to get loans. For relatively safe bonds backed by Fannie Mae and Freddie Mac, for instance, lenders a few weeks ago were requiring $102 in securities as collateral for every $100 in loans. The demand hit $105 last week. For bonds backed by 'Alt-A' loans, which some consider to be between subprime and prime in terms of credit quality, repo lenders are demanding as much as $130 of collateral for every $100 in loans. Repo disruptions helped doom a $21.7 billion mortgage fund, Carlyle Capital Corp., last week. Carlyle financed most of the fund's operations with low-interest repo credit to boost returns. Carlyle said one bank moved to reduce the size of the repo loans it made to Carlyle to 95% of the underlying value of the assets used as collateral, from 97%. Another dealer had reduced the value of the loans' collateral to "markedly lower levels than other banks." Data from the Federal Reserve last week showed that Wall Street dealers had accumulated around $66 billion in net holdings of mortgage-backed securities in their inventories, a historic high. Those levels have been unusually elevated for the last few weeks, and "mean that there has been a significant decline in liquidity in the mortgage market, which is resulting in dealers holding large amounts of assets," says Mustafa Chowdhury, head of U.S. rates research at Deutsche Bank in New York. In calmer times, those balances are typically below $30 billion.