NEW YORK: The cost for banks to fund securities purchases in the short-term markets rose on Wednesday as banks sought longer-dated funding and as investors shifted loans away from the largest US banks that are under review to lose their top short-term ratings from Moody's Investors Service.
Moody's is expected to complete its review of 15 of the largest global banks in the coming days or weeks, with Morgan Stanley, Citigroup and Bank of America all on review for possible downgrades of their top short-term credit ratings at their bank operating company levels.
Goldman Sachs is also under review to lose its top short-term ratings at its holding company but is not expected to lose them at the operating company level.
Concerns over the possible effect of the bank downgrades has helped send the cost of financing securities in the repurchase agreement market higher as lenders seek out alternative exposures to the banks under review.
The largest banks at risk of downgrade have also been extending the maturities of their borrowings to protect against potential disruptions when Moody's finalizes its review, which is helping push up the cost of loans.
"If they are downgraded there is a risk of their funding getting hurt or becoming more costly, so they are getting ahead of it," said Raymond Gilmartin, head of repo trading at Bank of Nova Scotia in New York. "We need to see the downgrades happen and when they happen there will be more normalcy in the market."
The cost of overnight repo loans backed by Treasuries rose to 25-to-28 basis points o n W ednesday, after closing at 21 basis points.
A lower short-term rating could mean a lender in the repo market charges a bank more for the loan, or requires more collateral or is more averse to taking riskier collateral to back the loan.
Money market funds that are rated by Moody's are unable to hold short-term debt that does not hold the highest rating from the agency, which means that banks that borrow from these funds are having to shift positions to other lenders, including non-rated funds, or seek out alternative financing sources.
Money market funds lend approximately $130 billion to the four large banks under review through repo, according to Barclays.
Another factor that may be pressuring repo funding rates higher is that more business is being done with smaller, lower-rated counterparties. This could be pushing the average borrowing rate higher.
The Federal Reserve has been pressuring the triparty repo industry to reduce concentration risk to the market from the three banks that dominate activity. The Fed does not disclose the names of these banks.
The effect of this is that the spread between higher and lower-rated borrowers is widening, and it may also be leading to higher rates, Barclays analyst Joseph Abate said in a report this week.
"We suspect that the 'democratization' of the triparty market more than direct balance sheet issues has led to the persistently higher financing rates," he said.
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