The Securities Lending Program performed well during 2014 by earning over $91.8 million. The program has averaged over $101 million in earnings over the past five calendar years. Program earnings continue to be a steady source of incremental income, generating over $1.35 billion for CalSTRS since its inception in 1988, adding, on average, over four basis points annually to the CalSTRS portfolio.
The securities lending markets have come nearly full circle from the financial crisis of 2008 and are continuing to show further signs of stabilizing. Program earnings slipped slightly year over year by $4 million, as an increasing number of institutions continue to get back into securities lending or increased the eligible types of collateral available to lend. While this increased supply benefits the securities lending marketplace in general by creating additional liquidity, it also dampens pricing, which lessens earnings potential. Demand to borrow individual securities with large spreads of return, often referred to as “specials,” held steady to slightly increasing in 2014, which helped income opportunities. However, this was offset by diminishing cash collateral yield, as the continued low interest rate environment makes it difficult for reinvestment opportunities. General collateral (non-special) trade spreads reduced over the year as well, causing a headwind to earnings. Dealer balance sheets continue to be pressured, given pending regulations which lowers borrower demand.
The regulatory environment for securities lending continues to remain uncertain going forward. Ongoing implementation and finalization of Dodd/Frank legislation, Volcker Rule and BASEL III regulations could potentially limit the amount of activity that counterparties can do with one another, in addition to potential cost increases for lending agents to indemnify their lending clients. As a result, Central Counterparties are being viewed as a possible alternative to help reduce counterparty and indemnification risk exposures. Staff continues to evaluate the ramifications of these potential rule changes to the program.
The common theme throughout the Investment Branch business plans for this year has been to apply the core mission to “Changing Environment.” The program sought to accomplish this by continuing to follow and review established policies and guidelines, despite a changing market landscape, with the goal of providing incremental alpha to the total fund. As a result, the program provided 4.88 bps in incremental return to the total fund over the past year.
Staff continued to move forward with implementation of the Securities Lending Request for Proposal process to refresh our lending agents and create a lending agent pool. Staff announced during the year that it would retain the program’s three current lending agents, while adding two new additional lending agents (Citigroup and eSecLending). Going forward, staff is working on updating contracts and finalizing the allocation of available securities for each lending agent to lend.
This annual report represents a review of CalSTRS’ Securities Lending Program for the calendar year ending December 31, 2014, along with any important updates subsequent to that period. Included is an overview of the program, the income earned compared to each of the previous years, and an analysis of the performance of each of the cash collateral portfolios.
Glenn Hosokawa, CFA,
Director of Fixed Income
Chief Investment Officer
December 31, 2014