Bank officials said their portfolio managers are carefully managing their way out of those collateral pools by waiting for long-duration asset-backed securities to mature and investing cash in short-term instruments to increase liquidity. Those strategies contributed to the eased restrictions and made it easier for retirement plan sponsors to tap index fund assets for what the banks call normal daily activities, such as rebalancing, benefit payments and 401(k) plan participant investment option changes.
Northern Trust's pools “are conservatively managed, stressing liquidity over yield with respect to portfolio construction. Liquidity in our collateral pools continues to be strategically managed to above-normal targets, but the marketplace still lacks a robust secondary market to facilitate the ordinary sale of assets before they mature,” John O'Connell, a Northern Trust spokesman, wrote in an e-mail response to questions.
Mr. O'Connell said that since January, clients have been able to withdraw what they need for their normal course of business, plus two more chances per month. But that's probably a lot less than many clients want.
State Street has changed the investment guidelines for its cash collateral pools to require that all cash be invested in short-term securities. Clients may now withdraw between 2% and 4% of assets in their accounts per month.
BNY Mellon also is now permitting clients to withdraw assets for normal daily operating activities, but “there are restrictions on some pools for unusual activity, such as for those exiting the program. These require an in-kind distribution, or a vertical slice of the assets in these pools, to protect the liquidity of the funds for the benefit of all pool participants. This policy helps us to avoid forced sales of investments, which could cause the unnecessary realization of losses, which would affect all participants in a fund,” said Mike Dunn, a spokesman, in an e-mail response to questions.
The easing of withdrawal restrictions has made the situation only “a little more manageable. We're really in a state of suspended animation now,” said Virgilio A. “Bo” Abesamis III, senior vice president and manager of master trust, securities lending and global custody at consultant Callan Associates Inc., San Francisco.
“A lot of people don't have good choices right now. There are pockets of liquidity, but the market hasn't eased up evenly for all securities in all markets. And there's still this lump of illiquid securities in most of the collateral pools. Everyone is stuck until the asset-backed market frees up,” said Stacy Scapino, New York-based global director of Mercer Sentinel Group, the risk adviser for Mercer's institutional client base.
Despite feeling a sense of relief that the banks “did what they said they would do in managing the cash collateral pool portfolios, namely, raise the bar to increase liquidity and to shorten duration of the securities,” consultant Cynthia Steer said she has concerns about the illiquid lump Ms. Scapino described.
“The question is what you get when the manager gets down to that last 20% of the portfolio. These are the least liquid and longest duration securities. How do you handle these? What's going to be left in there?” Ms. Steer asked, noting that some of these investments won't mature until 2010 and 2011. Ms. Steer is managing director and chief strategist of consultant Rogerscasey Inc., Darien, Conn.
Another question is “when will they lift the gate,” Ms. Steer said. “Will it be at 50% (of working through the illiquid securities)? 70%? 95%?”
Officials at Northern, State Street and BNY Mellon did not answer that question directly when posed by P&I.
BNY Mellon's Mr. Dunn said in an interview that the answer depended on the individual portfolio.
Northern Trust's Mr. O'Connell said in an e-mail that the “elimination of all restrictions on collateral pools can be contemplated when the market is deep and robust enough for participants to trade securities at prices that reasonably reflect their underlying credit quality. ... The market environment is likely to determine when those safeguards are no longer necessary.”
State Street is working to identify clients with similar objectives and is creating work-out plans that might shorten the time clients who want to exit the securities lending program have to wait, Peter Economou, executive vice president in the bank's securities financing unit, said in an interview.
Callan's Mr. Abesamis said institutional investors will have to decide whether the risk-reward factors inherent in securities lending are worth the staff time it takes to monitor the program.
“I think when institutions, especially smaller institutions, go through the risk budgeting exercise about securities lending, they will decide that it isn't worth devoting considerable resources to gain between one to three basis points, say $250,000. I think institutions will choose to seek alpha elsewhere, in alternative investments, for example,” he said.
Consultant Scott Whalen said if institutions agree to accept securities lending risks “when we get out of this rat hole,” they will “demand to get better paid for the risk taken or insist that securities lenders share the risk, not just profit from the upside profits as they do now.” Mr. Whalen is executive vice president and senior consultant, Wurts & Associates, Seattle.
