23 November 2013

The Dark Side of Shadow Credit Intermediation

Adam B AshcraftSenior Vice-President and Head of Credit Risk Management

2

Why does shadow credit intermediation exist? Why should we be concerned? What have we learned? What should we worry about now?

Outline

3

Why does shadow credit intermediation exist?

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

Traditional Maturity Transformation Shadow Maturity Transformation Traditional Credit Transformation

Shadow Credit Transformation Other Liabilities

Source: Ashcraft, Adrian, and Cetorelli (2013)

4

Regulatory arbitrage Neglected risks Funding fragilities Leverage cycles Agency problems

Why should we be concerned?

5

What went wrong?Asset-backed commercial paper

$-

$200.00

$400.00

$600.00

$800.00

$1,000.00

$1,200.00

$1,400.00

2001

-01

2001

-09

2002

-05

2003

-01

2003

-09

2004

-05

2005

-01

2005

-09

2006

-05

2007

-01

2007

-09

2008

-05

2009

-01

2009

-09

2010

-05

Non-Financial

Financial

ABCP

6

What went wrong?Money market mutual funds

0

500

1000

1500

2000

2500

0

500

1000

1500

2000

2500

Jan-08 Jul-08 Jan-09 Jul-09

Government

Billions of Dollars Billions of Dollars

Source: Moneyfundanalyzer Note: Shaded area September 16 - October 21

Prime

Figure 5: U.S. Money Market Fund Assets by Fund Type

Tax-free

7

What went wrong?Tri-party repo

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

1994 1997 2000 2003 2006 2009

Overnight Repo

Financial CP

M2

Mar 19 2008

Dec28 2009

Aug 8 2007

2.43

0

200

400

600

800

1000

1200

1400

1600

1800

0 20 40 60 80 100

Option Adjusted

Spread (bps)

Haircut (%)

May 2007

May 2008

May 2009

8

Securitization

$0

$100

$200

$300

$400

$500

$600

0

100

200

300

400

500

600

Mill

ions

Bon

d Co

unt

Total Bond Issuance

$ Count

9

What went wrong?Government Sponsored Agencies

FHLB Advances outstanding Non-FHLB vs FHLB Libor panel bid

Source: Ashcraft, Bech, and Frame (2008)

10

What went wrong?Credit Derivatives

-

10,000

20,000

30,000

40,000

50,000

60,000

70,000

Credit Derivatives, Notional ($billions)

11

What to worry about now?Agency Mortgage REITs

199920002001200220032004200520062007200820092010201120120

50

100

150

200

250

300

350

400

Remaining amREITs

(5th) ARMOUR Residential REIT Inc.

(4th) CYS Investments Inc.

(3rd) Hatteras Financial Corp.

(2nd) American Capital Agency Corp.

(1st) Annaly Mortgage Magement Inc.

$ Billions

12

What to worry about now?Reinsurance

This figure reports life and annuity reinsurance ceded by U.S. life insurers to affiliated and unaffiliated reinsurers. Reinsurance ceded is the sum of reserve credit taken and modified coinsurance reserve ceded.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2320921

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What to worry about now?Leveraged Lending

Share of new-issue institutional loan allocations by investor type

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 1Q13

CLO Prime-rate fund Hedge, distressed & high-yield funds Other

Source: S&P Capital IQ LCD

Covenant-lite volume $100B

$80B

Volume Percent

75%

60%

$60B 45%

$40B 30%

$20B 15%

$0B 0%

1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13

Source: S&P Capital IQ LCD

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What to worry about now?Chinese Shadow Banking

-20

0

20

40

60

80

100

120

140

-20

0

20

40

60

80

100

120

140

Dec-08 Aug-09 Apr-10 Dec-10 Aug-11 Apr-12 Dec-12

Entrusted loans

Trust loans

Net corp bonds (ex-banks)

China: Growth in Shadow Finance ComponentsPercent, y/y Percent, y/y

10

15

20

25

30

35

40

10

15

20

25

30

35

40

Dec-07 Oct-08 Aug-09 Jun-10 Apr-11 Feb-12 Dec-12

Total financing (incl off-balancesheet, trust loans, net corpbond/equity)

Bank loans

China: Bank Credit and Total Financing GrowthPercent, y/y Percent, y/y