Repurchase Agreements

Transcription

1 Repurchase Agreements Educational Session May 13, 2015 AMERICAN COUNCIL OF LIFE INSURERS 101 Constitution Ave., N.W., Washington, DC

2 OVERVIEW 2

3 What Is A Repurchase Transaction? Short-term collateralized investment or financing transaction One entity sells a security to another entity with an agreement to buy it back at a later date at a pre-determined price The economics of a Repurchase transaction are that of a collateralized loan Repurchase versus Reverse Repurchase transaction refers to which side of the transaction the party is on. Insurers that sell a bond and are raising cash are considered to have entered into a Repurchase transaction (SSAP 103 p.93) Insurers that purchase a bond and are investing funds are considered to have entered into a Reverse Repurchase transaction (SSAP 103 p. 102) 3

4 Why Do Insurers Use Repos? Repurchase Agreements Low-cost source of cash for spread lending and/or on a temporary basis for asset/liability management Provides attractive term funding Reverse Repurchase Agreements Used as a short-term investment by Treasury departments for efficient cash management 4

5 Repurchase Transaction Overview INCEPTION Insurer Sells Bond Funds Counterparty MATURITY Insurer Insurer Repurchases Bond Funds + Interest Counterparty In above example, counterparty will also pass any bond coupons back to the insurer 5

6 Who Participates In Repo Markets? Securities Dealers Hedge Funds & Mortgage REITs Central Banks (Including Federal Reserve) Money Market & Mutual Funds State & Local Governments Pensions & Insurance Companies 6

7 Size of Repo market Pre-Crisis Market ~$6.5 Trillion Primarily Intermediated by Dealers Current Market ~$4.5 Trillion 65% Treasuries Majority <3mo Term With ~50% Overnight Top 20 Life Insurers ~ $19 Billion as of 12/31/2014 Source: SIFMA 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 Market Size In $B 7

8 MECHANICS OF A REPO 8

9 Terms Impacting Initial Proceeds Market Price Of Securities sold to Repo counterparty Haircut - Varies by quality of securities being sold/financed, term of trade and counterparties For Insurers, typically effected without a haircut (i.e., 100%) However, if the Insurer is paying a haircut, the Insurer would receive less cash than value of securities sold For example, 5% haircut Insurer would receive $95MM cash collateral when selling $100MM (market value) Treasury Bond; at maturity of transaction counterparty would return 100% of the market value of the security Example - Assume Insurer is financing a $100 MM U.S. Treasury bond & paying a 5% haircut Securities Face $100mm Market Price 100 Haircut 5% Cash Proceeds or "Sale" = (Face * Price) * (100%-5%) = ($100mm x 100%) * 95%= $95mm INCEPTION Insurer Delivers $100mm Face U.S. Treasury Bond Repo Counterparty $95mm Cash 9

10 Terms Impacting Repurchase Price & Repo Rate Term of Repo - Typically higher funding costs for term vs. overnight borrowing Securities Lower quality securities are more expensive to finance/repo Haircut - Varies by quality of securities being sold/financed, term of trade and counterparties Example - Assumes $100 market value, U.S. Treasury Bond; Insurer paying a 5% haircut, 6 month term Initial Sale Term of Repo Repo Rate Repurchase Amount $95mm 180 days 40bpts $95.190mm Repurchase Price = Sale Proceeds(1+ (Repo Rate x (Days/360))) = 95mm x (1 + (.0040*180/360)) = mm $190k interest embedded in repurchase price MATURITY Insurer Returns $100mm Face U.S. Treasury Bond $95.190mm Repo Counterparty 10

11 Repurchase Transaction Documentation Standardized form agreements combined with an annex that is negotiated between the parties Master Repurchase Agreement published by SIFMA covers US transactions Global Master Repurchase Agreement published by SIFMA and the International Capital Markets Association Each transaction is reflected in a confirmation Obligations of both parties pursuant to multiple transactions under one agreement are netted Party acting as buyer of securities under one or more transactions may call for additional collateral on any day that market value of purchased securities is insufficient to support cash delivered to seller Party acting as seller of securities under one or more transactions may seek return of collateral on any day that market value of purchased securities is greater than necessary to support cash delivered to seller Transfer of collateral must occur within one business day 11

12 Repurchase Transaction Documentation, contd. Seller of securities is entitled to receive coupon payments on securities from buyer Events of default include (i) failure to deliver securities on purchase date, (ii) failure to return securities on repurchase date, (iii) failure to deliver or return collateral, (iv) failure to deliver coupon payments within one day s notice, (v) insolvency, (vi) failure of representations to be true or (vii) admission of inability to perform under the agreement Upon event of default, all transactions may be terminated immediately Lines of credit and collateral requirements are negotiated on a customer by customer basis 12

13 REPURCHASE AGREEMENT ACCOUNTING 13

14 Basic Components Receive cash Recognize a liability to return the cash Pledge financial assets as collateral Pay interest expense 14

15 Accounting Guidance: SSAP No. 103 Secured borrowings for reporting entity raising cash unless meeting all paragraph 8 sale criteria (paragraph 91) Underlying securities remain investments owned by reporting entity raising cash (paragraph 94) Proceeds from sale of securities recorded as a liability by reporting entity raising cash (paragraph 94) Interest expense reported (straight line or constant yield) for difference between proceeds and repurchase price (paragraph 94) Reporting entity raising cash (Repurchase Agreement) shall receive collateral (e.g. cash raised) having fair value of at least 95% of fair value of securities sold. (paragraph 104.a.) Reporting entity investing funds (Reverse Repurchase Agreement) shall receive as collateral transferred securities having fair value of at least 102% of purchase price paid. (paragraph 104.b.) 15

16 Accounting Entries Debits Proceeds 95 Credits Secured Borrowing 95.2 ($95 and interest thereon $0.2) Interest Expense 0.2 Basic entries for an agreement where a reporting entity sells securities for $95 and agrees to repurchase them at $95.2 on a specified date. (Repurchase Agreement accounted for as a Collateralized Borrowing under SSAP No. 103, paragraph 94) 16

17 Financial Reporting Assets (Page 2) Bonds * 100 Liabilities, Surplus (Page 3) Secured Borrowing 95.2*** Cash** 95 Interest Expense 0.2 Summary of Operations (Page 4) Statutory financial statement geography of repurchase agreement accounted for as collateralized borrowing * Financial assets held at carry value of $100, sold at 95% of their fair value (maximum haircut allowed under SSAP 103) with agreement to repurchase at $95.2. ** Proceeds received on sale of financial assets. ***Liability for return of $95 proceeds plus $0.2 interest. 17

18 Net Assets available to Policyholders Without Repurchase Agreements With Repurchase Agreements Assets Liabilities Assets Liabilities Bonds 100 Reserves 98 Bonds 100 Reserves 98 Cash 95 Secured Borrowing 95.2 Surplus Unassigned Funds 2 Surplus Unassigned Funds* 1.8 *Reduced via $0.2 interest expense through Summary of Operations Comparison of Statutory Financial Statement Assets, Liabilities and Surplus with and without Repurchase Agreements accounted for as Collateralized Borrowings. 18

19 RISKS AND HOW THEY ARE MANAGED 19

20 Counterparty credit risks Counterparties approved given expected types of activity Trading Repurchase Agreements / Securities Lending Derivatives Total exposure limits are set based upon available data Credit ratings Market risk indicators (CDS levels) Financial statements Repurchase agreement portion of total exposure Collateral Haircuts/Initial margins Tenor 20

21 Counterparty credit risk best practices Governance Executive committees Risk management Senior management Integrated process Monitor exposures Maintain risk controls Appropriate measurement metrics Legal documentation Standardized contracts GMRA MRA 21

22 Default Margin (Mark-to-Market) Defaults Counterparty cannot provide required margin on cash collateral given mark-to-market Insurer can terminate repurchase agreement transaction Insurer can withhold portion of cash collateral equal to margin Single Repurchase Agreement Transaction Defaults Counterparty cannot return specific security on repurchase transaction maturity date Insurer can utilize cash collateral to purchase security in open market Repurchase transaction can remain open with rate dropped to 0% until specific security can be returned Counterparty Defaults Counterparty cannot return any of the borrowed securities Insurer can utilize cash collateral to purchase securities in open market Subject to state bankruptcy laws 22

23 Reinvestment risk Liquidity Risk Inability to generate sufficient cash from reinvested assets and other sources necessary to repay repurchase agreement transactions Risk Controls -Maturity term diversification between open or overnight and term structures -Approved investment guidelines on appropriate mix of HLA (highly liquid assets) Credit Risk -Impact on capital losses from credit assets Risk Controls -Approved investment guidelines on appropriate overall credit quality (AA or better) -Approved investment guidelines on specific asset types Mismatch Risk -Mismatch between investments made with cash collateral and the dates the cash collateral must be returned may adversely affect balance sheet and negatively impact its surplus Risk Controls -Approved investment guidelines limit mismatch to generally one year 23

24 Re-Hypothecation Insurers cannot prohibit counterparties from selling or re-hypothecating (pledging to another party) assets received in a repurchase agreement Consequently, the Holders (borrowers) of securities may sell the borrowed asset but they remain obligated to pay coupon interest payments ( manufactured interest ) to the Insurer The Insurer (as lender ) retains beneficial ownership rights of the securities and implements a process to identify counterparties for collection on the respective coupon dates Example of Manufactured Interest Insurance company A repos a security to Counterparty A Counterparty A sells security to Counterparty B Insurance company A collects coupon interest payment from Counterparty A 24

25 Information and data Assets subject to repurchase agreements Remain on balance sheet Noted on investment schedules Coded at custodian banks Collateral Daily level of cash collateral marked-to-market against value of securities Amounts and maturity when cash collateral is due to counterparties Assets purchased with cash collateral included on balance sheet Counterparties Total exposure (including repurchase agreement levels) Market updates (CDS levels, LIBOR) Credit updates on approved counterparties 25

26 Risk-Based Capital Asset Risk (C-1) Asset risk charges apply to all assets subject to repurchase agreements Asset risk charges apply to all assets purchased with cash collateral Other (C-0) General interrogatory Amount of repurchase agreements open on reporting date Currently 130 basis point capital charge 130 basis points equivalent to C-1 charge for a NAIC 2 security The RBC charge is applied to the entire security even though the exposure is limited to the under collateralized portion (0-5%) 26

27 RECOMMENDATIONS FOR INCREASING TRANSPARENCY 27

28 Existing Reporting/Disclosure Schedule D Reports All Assets Subject To Repurchase Agreements Assets tagged with identifier in code column of schedule D Schedule D bonds aggregated at CUSIP level so total amount of tagged securities may overstate population Schedule DA reports reverse repurchase transactions as short term investments Note 5 Disclosures Aggregate book and fair values of securities transferred along with borrowing cost Book and fair values of collateral received and reinvested by tenor of repurchase agreement Qualitative disclosure of collateral policies and sources of liquidity to manage duration mismatches 28

29 1) Consider Revisions to Reporting / Disclosure Framework Schedule D has a code column for flagging securities loaned subject to repurchase agreements Schedule D captures securities at CUSIP level Often companies have multiple bonds of the same CUSIP, but only some loaned or subject to a repo agreement so Schedule D won t tie out to Note 5 Could consider alternative mechanism for capturing bond-level data on securities subject to repos/securities lending Schedule DL Captures Reinvested Cash Collateral for Securities Lending Could consider similar schedule for securities subject to repurchase agreements Could also consider disclosures around credit risk exposure 29

30 2) Adopt New U.S. GAAP Disclosures June 2014, FASB Issued ASU Regarding Repurchase-to- Maturity Transactions, Repurchase Financings, Sec. Lending And Disclosures Impacts To Entities Will Be Added Disclosures For Repos and Securities Lending Accounted For As Secured Borrowings, As Follows: 1. Disaggregation Of Gross Obligation By Class Of Collateral Pledged 2. Remaining Contractual Tenor Of The Agreements 3. Discussion Of Potential Risks Associated With Agreements and Related Collateral Pledged 30

31 U.S. GAAP Disclosure Example 31

32 2013 FSB Disclosure Recommendations In 2013, the Financial Stability Board Made Recommendations to Strengthen Oversight and Regulations of Repos and Securities Lending, Including Improvements In Corporate Disclosures FSB Recommendation In SAP For Repos/Securities Lending Today? Overall Breakdown of All Securities Yes, Restricted Assets footnote No Pledged as Collateral Maturity Breakdown of Trades Yes, Note 5 Yes Composition of Collateral Received Yes, at a high level in Note 5 No Composition of Securities Transferred and Received Counterparty Concentration Yes, Securities transferred reported using Schedule D code column (with limitations) Note 27 requires disclosure of significant concentration risk for all financial instruments, not explicit to repos In New GAAP Disclosure? Yes No Information on Collateral Margins Credit Risk Exposure By Type (Repo, Reverse Repo) No, but statutory collateral rules make this disclosure less critical No No No

33 RECAP/SUMMARY 33

34 Summary Insurers represent a small part of the overall repo market Repos are a safe, low cost source of funding Risks are appropriately managed and covered by existing RBC charges Robust reporting and disclosure framework exists today, regulators could consider additional disclosures 34