Securities Lending Q1 Update

• Lending revenues improve 3% compared with Q4 2018
• Government bond balances and revenues decline
• EUR denominated corporate bonds in demand
• Asia remains bright spot for equity lending, particularly Japan & South Korea

Global securities lending revenues for Q1 2019 came in at $2.4bn, 10% lower than Q1 2018. The good news is that the Q1 revenue also reflects 3% sequential improvement compared with Q4 2018. Equity lenders have seen a lack of specials balances, while there has been some marginal cooling in previously hot market segments including government bonds, corporate bonds and ETFs. The revenues are within the range of the preceding four quarters, however the breakdown of returns continues to evolve with changing needs of market participants.

Lending of government bonds, particularly US Treasuries, has taken on an increased significance in recent years. The demand driver has largely been the collateral needs of broker-dealers in relation to regulatory requirements for holding high quality liquid assets (HQLA). Apart from collateral needs, the Federal Reserve's path of rate hikes has created trading opportunities in recent years, which has also driven borrow demand. That tailwind is losing momentum, as total government bond loan balances have declined steadily from the post-crisis peak in Q1 2018, which was over $1T USD. Along with balances, revenues are also declining, falling 9% compared with Q4 2018. Though overall revenues were challenged, there were some short-term opportunities to lend 10Y and 30Y bonds at special rates in Q1.

Corporate bond demand has been robust, with Q1 having the highest average loan balances for a quarter since 2010, just over $200bn. Demand for dollar denominated credit has been consistent, with the bulk of recent growth seen in EUR and GBP denominated credits. Despite solid demand, revenues fell YoY in Q1 as the result of declining fees.

ETFs took a pause after an impressive period of increasing revenues, posting a 16% decline compared with Q1 2018. Half of the decline was accounted for by a single credit ETF (HYG) as the result of declining fees in Q1. While the revenues for ETF lenders are on pace to fall short of 2018's record, they appear likely to exceed the 2017 total, the 2^nd highest revenue year on record.

Equity lending revenues came in at $1.9bn, a decline of 7.5% percent compared with Q1 2018. The bright spot continues to be Asia, the only region to improve on equity lending revenues YoY in Q1. Asia equities also contributed to ADR revenues, which posted the most quarterly revenue on record at $128m. Chinese electric carmaker Nio, listed on NYSE, drove the increasing revenue. Things were less upbeat in the West, with US and EU equity revenues both declining by more than 10% compared with Q1 2018. The blistering rally in expensive to borrow equities in January has kept a lid on specials demand. Some opportunities for US equity lenders have emerged on the back of corporate actions, most notably the Eli Lilly exchange offer for its holdings of Elanco Animal Health.

Last year delivered the most securities lending revenues since the financial crisis, which looks like a tough act to follow in the early going of 2019. The last two quarters have been notable in that there hasn't been the pickup in borrow demand which often accompanies periods of increased volatility. Most recently, in Q4 2015 - Q1 2016, US equities had the two best post-crisis revenue quarters amid the credit and equity sell-off as investors hedged and added to shorts. There was no such increase in Q4, though there is some cause for optimism with Q1 revenues at least mounting some growth while market values recover. Asia remains the bright spot for equities, with sovereign bonds and corporate credits declining from peak revenue but remaining elevated.

Stay tuned for the full quarterly review in two weeks!

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This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.