A growing minority of institutional investors has been axing their securities lending programs, concluding that the risks have become too great for the incremental income they've been earning.
Investors who've stopped lending out their holdings over the past year include the $45.7 billion Massachusetts Pension Reserves Investment Management Board, Boston; the $1.3 billion City of Hartford (Conn.) Municipal Employees' Retirement Fund; and the $1 billion University of Colorado Foundation, Boulder.
The risks first surfaced this year in the investment vehicles where managers of securities lending programs — including big custodial banks such as Northern Trust Corp., Chicago, and Bank of New York Mellon Corp., New York — park the cash collateral they receive from borrowers. That collateral is typically 102% of the value of domestic shares and 105% of the value of non-U.S. shares.
Institutional investors thought the collateral was invested in safe, plain-vanilla securities. Somewhere after 2000, however, the range of permissible investments was expanded to include things such as asset-backed securities and home equity loans, which have been eviscerated by the credit crisis, said Cynthia Steer, chief research strategist with investment consultant RogersCasey, Darien, Conn.
One corporate pension fund executive, who declined to be named, said he's been surprised to learn just how much long-dated paper — with maturities of five years to 25 years — was in his program's cash-collateral vehicle, which is designed to offer daily liquidity.
In previous rare cases where cash collateral pools have faced losses, “the lending agent/manager” usually stepped in to buy the bad assets “in order to bury the story,” said an executive with another multibillion-dollar corporate defined benefit plan, who likewise declined to be named. This time, however, the losses have been too big for the managers to absorb, he said.
While a loss from securities lending is a problem in and of itself, “it's the surprise of the loss that's more painful,” the executive said.