The Use and Abuse of the Primary Dealer Credit Facility

Includes: BAC, BCS, C, GS, JPM, MS, UBS, XLF
by: Reggie Middleton

Primary Dealer Credit Facility

Note: Paying subscribers may download the fully scrubbed model containing all of the date output by the Fed regarding the PDCF as an Excel pivot table here, Primary Dealer Credit Facility Analysis. Those who are interested in subscribing to our research should click here.

Yesterday, I illustrated how the Fed buried TARP 2.0 amongst a spreadsheet dump of over 70,000 trades and what amounted to probably a million cells of spreadsheet data distributed among a plethora files. Today, we will review another one of those files, dealing with the lending program that the Fed instituted for its Primary Dealer bank.

The Primary Dealer Credit Facility (PDCF) was created in March 2008 as an overnight loan facility that provided funding to primary dealers in exchange for a specified range of eligible collateral. The PDCF was intended to foster the functioning of financial markets more generally. The facility expired on February 1, 2010. Analysis of the Primary Dealer Credit Facility data provided by the Fed reveals some appalling facts.

1. A total $8,959bn was loaned to financial institutions (including rollover) with a weighted average interest rate of 1.53 percent. The total collateral against this $8,959bn of loan was $9,665bn, a mere 7.88% overcollateralization in a time of distress and rapidly deteriorating assets. The quality of the collateral posted for PDCF was pitiable. Only 1.4% of the collateral, on average, was traditional collateral posted in the form of U.S. Treasury or agency debt, while corporate securities topped the list with 24% followed by equity at 22% and municipal bond at 14 percent. Collateral as indicated by rating points to the fact that almost 65% of collateral was either junk or equities. Of the total collateral, 42% was virtually pure junk consisting of MBS / BBB / BB / B / CCC and unrated instruments and equities constituted 23% of collateral.

Of the total collateral, 15% was unrated, 7% MBS, 6% BBB, 4% BB, 4% B and 5% CCC or lower. Only 20% of collateral was AAA while 32% was rated A and above. Basically, the Fed simultaneously became the dumping ground for all of the trash that the nation’s big banks needed to get rid of and the world’s largest vulture fund, it’s just that it paid premium prices for the junk.

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2. Citigroup (NYSE:C) was the biggest user of PDCF, utilizing almost 20% of PDCF, followed by Merrill Lynch (17%), Morgan Stanley (NYSE:MS) (15%) and Bear Stearns (11%). Of the 20 primary dealers, these four banks were the largest users of PDCF. Of these four, all either collapsed or were rescued, save Morgan Stanley, and we issued stern warnings regarding Morgan’s predicament in February of 2008 (see The Riskiest Bank on the Street). It appears we were definitely on to something!

3. Barclays (NYSE:BCS) took out the single biggest loan ($48bn) under the PDCF in September 2008. Of the top 20 single largest users of PDCF in a day, Morgan Stanley topped the list by appearing 16 times - again, referencing The Riskiest Bank on the Street.

4. Goldman’s (NYSE:GS) 86% of collateral consisted of junk securities, including equities (48%) while JP Morgan's (NYSE:JPM) 88% of collateral consisted of MBS / BBB / BB / B / CCC and unrated instruments -- the worst of the lot -- followed by UBS (NYSE:UBS) (71%) and Citigroup London (70%). We have also warned about the Street and the media overestimating the strength and health of JPM Morgan (see An Independent Look into JP Morgan).

5. Citigroup tapped the facility 279 times, followed by Merrill Lynch (226 times), Morgan Stanley (122) and Bank of America (NYSE:BAC) (118). The use of PDCF was highly concentrated, with the top four banks amongst them using almost 70% of the facility.

6. During September 2008 alone, financial institutions collectively borrowed $1,192bn from the Primary Dealer Credit Facility.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.