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A Reversal of Fortune

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  • A Reversal of Fortune

    Exclusive: Borrowers turn lenders as banks tap firms for cash

    11:46am EST
    By Douwe Miedema

    LONDON (Reuters) - Blue-chip names like Johnson & Johnson (JNJ.N: Quote, Profile, Research, Stock Buzz), Pfizer (PFE.N: Quote, Profile, Research, Stock Buzz) and Peugeot (PEUP.PA: Quote, Profile, Research, Stock Buzz) are among firms bailing out Europe's ailing banks in a reversal of the established roles of clients and lenders.

    One source with knowledge of the so-called repo deals or short-term secured lending, said the two U.S. pharmaceutical groups and French carmaker were the latest to sign up for them.

    Europe's banks are struggling to secure the cash to fund their day-to-day business and have largely stopped lending to each other for fear Europe's sovereign debt crisis could land any of their peers in trouble.

    As a result a group of well-known, cash-rich companies with solid cash flows has stepped in the repo market, which provides a form of lending so far almost exclusively in use between banks, and between banks and central banks.

    One market participant said in one key area of lending companies now accounted for 25 percent of these deals.

    Repos provide the new financiers with the strict guarantees they need before parting with their cash, answering worries that the crisis has weakened Europe's banks to the extent that they might not be able to pay the money back.

    "Companies in the past were ... happy to deposit cash on an unsecured basis to a bank for an interest payment," said Frank Reiss, who oversees some of the repo business at Euroclear, the Brussels-based settlement house owned by a group of banks.

    "Now following the crisis, we have seen that companies are engaging in repos secured with collateral against the cash they are lending," said Reiss. Euroclear is the largest administrator of repo trades in Europe.

    At the moment the European Central Bank provides the main lifeline for banks and has pumped hundreds of billions of euros of cash into the market.

    But the banks are parking most of the money they borrow back at the ECB rather than trusting to lend to each other.

    They are also paying insurers and pension funds to take their illiquid bonds in exchange for better quality ones, in a desperate bid to secure much-needed cash from the ECB, which only provides cash against collateral.

    In stark contrast, Europe's biggest companies are sitting on cashpiles that amount to more than $20 billion each in the case of BP Plc (BP.L: Quote, Profile, Research, Stock Buzz) and Volkswagen (VOWG_p.DE: Quote, Profile, Research, Stock Buzz).

    According to Moody's, a sample of European companies held $872 billion cash in total at the middle of 2011.
    It is typically these very large companies, with reliable cash flows, that engage in repo deals with banks, Euroclear's Reiss said, though he declined to give the names of any counterparties, because of client confidentiality.

    Corporate treasurers are typically extremely wary of talking about their day-to-day cash management, and Johnson & Johnson, Pfizer declined to discuss the matter. Peugeot was not available for comment, while other large companies contacted by Reuters also declined comment.


    Regulators cracking down on "shadow banking" -- closed-door deals blamed in part for the 2008 financial crisis -- have expressed worries about how opaque the repo market is, and the U.S. Federal Reserve has set up a working group to suggest reforms.

    The rise in repos means more business for companies such as Euroclear and its main rival Clearstream -- owned by Deutsche Boerse (DB1Gn.DE: Quote, Profile, Research, Stock Buzz) -- as well as Bank of New York Mellon (BK.N: Quote, Profile, Research, Stock Buzz), JP Morgan (JPM.N: Quote, Profile, Research, Stock Buzz) and State Street (STT.N: Quote, Profile, Research, Stock Buzz).

    In a repo trade, one party buys collateral from the other, with the obligation to sell it back at a pre-defined later date and for a slightly lower price -- the so-called haircut. That way, the seller provides cash to the buyer.

    When companies rather than banks engage in repo deals they typically rely on a third party for administering the collateral, in what are known as triparty repos.

    The triparty market grew at 22.3 percent in the first half of last year, a survey by the International Capital Market Association (ICMA) showed, versus only a modest rise in the overall business, further prove that companies are increasingly accessing the market.

    "It shows you that triparty is growing, but ... not the banks themselves," said Richard Comotto, an academic who is involved in drawing up the survey. "I would say triparty is very growing strongly among corporate treasurers."

    The European repo market was worth 6.2 trillion euros ($7.88 trillion) in the first half of 2011, according to ICMA's September survey. The vast majority of business conducted was between banks, and banks and central banks.
    Other than the ICMA survey, few numbers are available.

    Based on his daily practice, Euroclear's Reiss estimated that up to 25 percent of the triparty market was on behalf of companies, a massive and sudden rise from the 2 to 5 percent where it had traditionally been.

    ($1 = 0.7865 euros)

    (Reporting by Douwe Miedema)