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.
Credit Limits
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 (OTCDTOTL) markets, the Fed said.
Measures of stress in credit markets soared during the three-month period surveyed to the worst levels in more than two years as Europe’s fiscal imbalances intensified, fueling concern that the region’s upheaval would taint bank balance sheets globally,
The U.S. 2-year swap spread (USSP2) rose 40 percent in the three- month period to 41.55 basis points as of Nov. 30 after peaking at 59.25 on Nov. 22, according to data compiled by Bloomberg. The difference between the two-year swap rate and the comparable-maturity U.S. Treasury note yield expanded to 48.63 basis points today.
Another signal of weakness in the banking system, the spread between the three-month London interbank offered rate, or Libor, and the overnight index swap rate, has more than 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.
Interbank Lending Divergence
While the Fed said today that 80 percent of dealers reported lowering credit limits for some specific financial- institution counterparties, evidence grew that banks were growing more wary of lending to each other.
The gap between the highest and the lowest rates that banks say they can borrow from each other in dollars is close to a 2.5-year high.
The divergence from reported fixings by the 18 banks contributing to the three-month London interbank offered rate reached 28 basis points today, within two basis points of the widest since May 2009. Libor (US0003M) for three-month loans climbed to 0.581 percent, the most since July 2009, even as central banks injected cash into the market.
U.S. economic data released today may point to some easing of terms for bank customers as the world’s largest economy improves. Companies cranked out more goods in December and pending sales of existing homes jumped in November for a second month.
‘Signs of Life’
The Institute for Supply Management-Chicago Inc. said its business barometer (CHPMINDX) was little changed at 62.5 from a seven-month high of 62.6 in November. The index (SPX) of signed contracts (USPHTMOM) to buy previously owned houses rose 7.3 percent after climbing 10.4 percent the prior month, the National Association of Realtors said. Both figures surpassed the median estimate of economists surveyed by Bloomberg News.
“2011 is ending on a solid note,” said Ryan Sweet, a senior economist at Moody’s Analytics Inc. in West Chester, Pennsylvania, who forecast a reading of 63 for the Chicago index. “Manufacturing has some momentum,” he said, and “we’re starting to see some signs of life in housing.”
Combined with a drop in firings over the past month and improving consumer confidence, the data show the world’s largest economy may be strengthening enough to fend off major damage from the European debt crisis. Stocks rallied, buoyed by the stronger-than-projected readings and by a decline in Italian borrowing costs and a benchmark gauge of U.S. company credit risk dropped to a three-week low.
Corporate Credit Risk
The Markit CDX North America Investment Grade Index of credit-default swaps, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, declined 2 basis points to a mid-price of 119.9 basis points at 4:52 p.m. in New York, according to data provider Markit Group Ltd.
The swaps index, which typically falls as investor confidence improves and rises as it deteriorates, has declined from 127.8 on Nov. 30. It rose from 114.5 at the end of August to 150.1 on Oct. 3, the highest level since May 2009.
Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
The Standard & Poor’s 500 Index climbed 1 percent to 1,263.02 at 4:33 p.m. in New York. The yield on the benchmark 10-year Treasury (USGG10YR) note fell two basis points, or 0.02 percentage point, to 1.9 percent, according to Bloomberg Bond Trader prices.
Dealer Report
The Federal Reserve began querying dealers 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 Fund Leverage
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.
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.
The Fed’s balance sheet (FARBAST) 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.
To contact the reporters on this story: Scott Lanman in Washington at slanman@bloomberg.net; Matthew Leising in New York at mleising@bloomberg.net
To contact the editors responsible for this story: Carlos Torres at ctorres2@bloomberg.net; Alan Goldstein at agoldstein5@bloomberg.net
http://www.bloomberg.com/news/2011-12-29/fed-says-dealers-tighten-terms-on-hedge-fund-securities-trades.html
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