Gary Peart ... to make up revenue from fee income.

At least one dealer in government paper and other securities, as well as the regulator for the financial services sector, are pointing to interest rates and liquidity risks in repurchase agreement or repo transactions, while brokerage Mayberry Investments says it is getting out of the business.

Mayberry's decision goes a little further than the Financial Services Commission is recommending, but the securities watchdog is concerned that brokerages' portfolios are too heavily skewed in one direction.

A realignment

"The FSC is not encouraging dealers to get out of the repo business, but is encouraging a realignment of their business model to guarantee alternative sources of income," Everton McFarlane, the FSC's senior securities director, said this week in an emailed response to Financial Gleaner queries.

None of the brokerages contacted were ready to speak immediately on the issue this week - some saying they were still studying the issue.

One senior analyst said repos was a "bread and butter" issue for securities firms, and that any realignment would have to be carefully assessed.

The sale and agreed buy-back of collaterised securities, usually government-backed paper, at guaranteed rates of interest, and facilitated by securities dealers, have been a popular means for companies to raise short-term cash.

The 30-day and 90-day tenors tend to be the most heavily subscribed.

Dealers make an interest income from the difference between the sale and the agreed repurchase price.

Small portfolio

Mayberry's repo portfolio at $14 billion is relatively small when matched, for example, against the $54.8 billion of repos that big broker NCB Capital Markets reported on its balance sheet last year.

Uncertainty about the future of interest rates and the effect on margins, appears to have figured in the Mayberry decision.

"The fourth quarter 2008 has convinced us more than ever that Mayberry will close this business line in an orderly fashion," chairman, Christopher Berry disclosed in his annual report to shareholders this month.

Mayberry posted a marginal rise in net interest income at $53.6 million in the March quarter, against $51.8 million for the same period the previous year.

"What we expect to see is that as we move out of repos our net interest income will continue to fall but this is going to be offset to a certain degree by increase in fee income," said Gary Peart, Mayberry's chief executive officer.

"Regardless of the volatility in interest rates, you know that you will earn that fee," he told the Financial Gleaner.

Collaterised repurchase

While neither Berry nor Peart raised the matter of liquidity risks arising from repos, notes to the financial statement of the listed firm explained that said companies from time to time enter into collaterised repurchase and reverse repurchase agreements, which may result in credit exposure in the event that one party to the transaction is unable to fulfil its obligation.

Raising the liquidity red flag, the FSC said it was encouraging securities firms to diversify their product offerings.

"A significant share of the funds under management portfolio of securities firms is accounted for by liabilities to clients arising from repurchase transactions," said McFarlane.

"Over the years, securities firms have operated a business model whereby large volumes of investments in securities are financed by the firms entering into short-term repo agreements with their investing clients, instead of selling such securities outright to the clients or selling the securities into registered CIS vehicles for the benefit of their clients."

CIS refers to collective investment schemes.

Under this model, the FSC says, the securities firms have essentially entered into a "borrowing relationship" with their clients, laying themselves open primarily to liquidity and interest rate risks.

Billions in repos

Approximately two thirds, or $14 billion of the $21 billion, of Mayberry's liabilities are in repos.

Among the biggest brokers, Jamaica Money Market Brokers had $92.5 billion in repos of $99 billion in liabilities, Pan Caribbean Financial Services had $42 billion of repos among $56.7 billion in liabilities, Scotia DBG Investment, $40 billion repos among total liabilities of $41.5 billion, while NCB Capital Markets had total liabilities of $58.8 billion with repos accounting for $54.8 billion.

Notwithstanding the backing by Government of Jamaica debt securities as collateral for the repos, the FSC is raising concerns about the risks inherent in these business practices and says it is moving to increase the margin of safety in the system.

Among the measures the securities watchdog said it has taken to limit the exposure are imposition of a minimum margin requirement for repo transactions, putting in place a cap on the size of a firm's repo stock in relation to its total liabilities, and approving other products, which dealers can offer their clients.

sabrina.gordon@gleanerjm.com