Bloomberg News

Fed Says Dealers Tighten Terms on Hedge-Fund Securities Trades

January 03, 2012

Dec. 29 (Bloomberg) -- Wall Street dealers made it tougher for hedge funds to finance trading of securities and derivatives in the three months through November, a Federal Reserve survey showed today.

Responses “indicated a broad but moderate tightening of credit terms applicable to important classes of counterparties,” especially hedge-fund clients, trading real estate investment trusts and nonfinancial corporations, according to the quarterly survey of senior credit officers at 20 dealers covering the period of September to November. The central bank released the report in Washington.

The report adds to evidence of stress in the financial system from Europe’s sovereign-debt crisis. Investor concern about the continent’s turmoil has helped drive the premium banks pay to borrow dollars to the highest in more than two years. The Fed survey didn’t discuss causes of the tighter financing terms.

Respondents reporting tougher borrowing terms for hedge funds “most frequently pointed to a worsening in general market liquidity and functioning and to reduced willingness to take on risk and, to a lesser extent, adoption of more-stringent market conventions and deterioration in the strength of counterparties as the reasons,” the Fed said.

The Fed’s Senior Credit Officer Opinion Survey on Dealer Financing Terms was conducted from Nov. 15 to Nov. 28. Respondents, who aren’t identified, “account for almost all of the dealer financing of dollar-denominated securities for nondealers and are the most active intermediaries” in over-the- counter derivatives markets, the Fed said.

Credit Limits

Eighty percent of dealers also reported lowering credit limits for some specific financial-institution counterparties, the Fed said.

The central bank began the report in 2010 as part of efforts to boost surveillance of financial markets following the panic of 2007-2008 that caused the worst economic downturn since the Great Depression.

The prior survey, covering June through August, showed that 86 percent of respondents reported that the number of dealers tightening financing rates outnumbered those easing.

The latest responses “reflect an apparent continuation and intensification of developments already in evidence in the September survey,” the Fed said today. About one-third of respondents tightened pricing terms, such as financing rates, to hedge funds, while one-fourth reported tightening nonprice terms including maximum maturity, the central bank said.

Hedge Funds

At the same time, more than half of dealers “indicated that hedge funds’ use of financial leverage, considering the entire range of transactions with such clients, had decreased somewhat over the past three months,” the Fed said.

One measure of stress in the banking system, the spread between the three-month London interbank offered rate, or Libor, and the overnight index swap rate, has doubled in four months to 0.49 percentage point today. That’s the widest since May 2009, as financial markets were still recovering from the collapse of Lehman Brothers Holdings Inc.

The Fed survey also found that liquidity and functioning were little changed in the U.S. Treasury securities market since the second quarter, while one-fifth of respondents said equity- market functioning had “deteriorated somewhat.”

The European Central Bank’s balance sheet ballooned this month to a record 2.73 trillion euros ($3.53 trillion) on a surge in loans to financial institutions. The ECB last week awarded 523 banks three-year loans totaling 489 billion euros to encourage lending to companies and households and prevent a credit shortage.

Currency Swap

The Fed’s balance sheet has also increased this month to a record, reaching $2.92 trillion last week, on dollar loans to European banks through currency-swap lines.

The ECB this month cut its benchmark interest rate to 1 percent, matching a record low, as the debt crisis threatened to engulf Italy and Spain, the euro area’s third- and fourth- largest economies. The Fed has been considering further measures to ease U.S. borrowing costs and protect the economy from the European turmoil.

--With assistance from Matthew Leising in New York. Editors: Gail DeGeorge, Carlos Torres

To contact the reporters on this story: Scott Lanman in Washington at slanman@bloomberg.net

To contact the editors responsible for this story: Carlos Torres at ctorres2@bloomberg.net


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