Shadow Banking not that Shadowy, says Cantor

An article in the June 1, 2012 Business Week by Jody Shenn and Lisa Abramowicz, “Cantor Plans to Enter Shrinking Shadow Banking”, took us by surprise. Cantor Fitzgerald is starting a repo conduit called Institutional Secured Funding. For those who aren’t familiar with repo conduits, they are classic shadow banking. Traditional repo conduits allow securities dealers to obtain financing for the weird, wonderful and illiquid by repo’ing in those assets and issuing asset-backed commercial paper (ABCP) to fund themselves. Ratings agencies rely on the credit worthiness of the repo bank to support the repo conduits’ rating and could pretty much care less about the collateral. So the paper that goes in can be stuff that otherwise might not be eligible in tri-party shells or for bi-lateral repo trades.

When the ABCP market shut down post-2007, many repo conduits found it hard to raise liquidity, especially in the term markets. They suffered, perhaps a bit unfairly, alongside other SPVs that issued ABCP for funding. Those off-balance sheet SPVs were the poster children for non-backstopped off-balance sheet leverage, opacity and risky maturity transformation and paid dearly when liquidity evaporated. Repo conduits shared many of those characteristics, but had a “take out” from the underlying repo bank, be that as it may. The lack of availability of funding for SPVs in general, and repo conduits in particular, was one of the primary drivers of market-wide deleveraging. The BW article quoted the size of the ABCP market at $232.6 billion (as of 2011), versus $1.2 trillion in 2007. Those numbers speak volumes about how investors ran away from “story CP”. Is it time for a bounce? Will yield hungry investors look to Cantor’s repo-backed ABCP to get a little more juice?

We would be surprised if regulators don’t wince just a little bit at the visit from structured securities financing past. Cantors press said that repo counterparties must be rated at least A1/P1. Certainly with the threatened Moody’s bank downgrades, which could flow down to the repo conduit ABCP ratings, it smells like an accident waiting to happen. Inserting a SPV into the mix brings in a level of opacity about the underlying collateral that ought to give investors flashbacks. 

 A link to the Business Week article is here.