US equity lending relies on fewer hot stocks, says IHS Markit
29 November 2019 London
Image: Shutterstock
Revenues for US equity lending have been concentrated in relatively few 鈥榮pecials鈥�, delivering outsized returns for holders of the in-demand shares. The revenue generated by the top-10 US equities totalled $785 million year-to-date (YTD) through 15 November, just over 31 percent of the total revenue generated by lending US equities over that time.
For context the contribution from the top-10 US equities averaged 25 percent from 2010 through 2018; the contribution from the top 10 US equities hasn鈥檛 exceeded 30 percent of revenue since 2012 when Tesla and Kinder Morgan both generated just over $130 million in revenues. In a similar vein the percentage of total global equity lending revenue from the top-10 US equities is on pace to be 11 percent for 2019, exceeding 10 percent for only the second time in the past decade.
Beyond Meat alone has generated 12 percent of 2019 YTD revenues for US equities. The outsized returns for Beyond Meat are most like Tesla in 2016 (see graph above), which generated $350 million in revenue that year, 11 percent of the US equity total. Since 2010 Tesla is the only US equity to generate more than 10 percent of US equity lending revenues for a full calendar year.
While the revenue contribution from the top-10 stocks has increased this year, it appears to have peaked in Q3 and is on pace to decline in Q4. One key driver of lower fees for previously hard to borrow shares have been lockup expiries, with recent notable examples being Beyond Meat, Lyft and Uber. The US equity value on loan where the fee is greater than 500bps reached $13 billion on 8 October, before tumbling 45 percent to $7.2 billion on 15 November.
While the 2019 vintage initial public offerings have seen lending fees decline with lockup expiries, there is another driver of lower revenue from specials in Q4, namely the sharp decline in valuations for the Cannabis sector, with several firms in the space seeing their share price decline by more than 50 percent from their 52-week high. US listed Cannabis stocks delivered $317,000 in average daily revenue in Q4, down 24 percent from the Q3 average. The declining US cannabis equity lending revenue is the result of both declining balances and fees relative to Q3.
The most expensive to borrow US equities have 0.18 percent average monthly return for 2019 through the second week of November, reflecting an average 1.6 percent monthly underperformance relative to the rest of US equities.
That means a shareholder would need to be able to lend the most expensive to borrow US equities for at least 13.4 percent annualised fee in order to break even with the decline in share prices relative to easier to borrow shares. At present, the average fee for those securities is only 9.6 percent.
That may be good news from a demand perspective, however, as short sellers have been able to generate positive returns from shorting the most expensive to borrow US equities relative to easy to borrow shares in each month since March. The positive returns to shorting the most expensive to borrow US equities could support an increased willingness to pay up for hard to borrow shares heading into 2020. That paints a very different picture from January and February of this year, when the most expensive to borrow US equities outperformed the rest of US equities by 1.7 percent and 2 percent, respectively.
The tailwinds for short sellers of hard to borrow US equities may result in increased willingness to pay up to borrow shares, however the increased concentration in the shares of relatively few firms is a risk factor for lenders given that the revenues for US equities outside the top 10 are on pace for a fourth consecutive annual decline in revenues.
For context the contribution from the top-10 US equities averaged 25 percent from 2010 through 2018; the contribution from the top 10 US equities hasn鈥檛 exceeded 30 percent of revenue since 2012 when Tesla and Kinder Morgan both generated just over $130 million in revenues. In a similar vein the percentage of total global equity lending revenue from the top-10 US equities is on pace to be 11 percent for 2019, exceeding 10 percent for only the second time in the past decade.
Beyond Meat alone has generated 12 percent of 2019 YTD revenues for US equities. The outsized returns for Beyond Meat are most like Tesla in 2016 (see graph above), which generated $350 million in revenue that year, 11 percent of the US equity total. Since 2010 Tesla is the only US equity to generate more than 10 percent of US equity lending revenues for a full calendar year.
While the revenue contribution from the top-10 stocks has increased this year, it appears to have peaked in Q3 and is on pace to decline in Q4. One key driver of lower fees for previously hard to borrow shares have been lockup expiries, with recent notable examples being Beyond Meat, Lyft and Uber. The US equity value on loan where the fee is greater than 500bps reached $13 billion on 8 October, before tumbling 45 percent to $7.2 billion on 15 November.
While the 2019 vintage initial public offerings have seen lending fees decline with lockup expiries, there is another driver of lower revenue from specials in Q4, namely the sharp decline in valuations for the Cannabis sector, with several firms in the space seeing their share price decline by more than 50 percent from their 52-week high. US listed Cannabis stocks delivered $317,000 in average daily revenue in Q4, down 24 percent from the Q3 average. The declining US cannabis equity lending revenue is the result of both declining balances and fees relative to Q3.
The most expensive to borrow US equities have 0.18 percent average monthly return for 2019 through the second week of November, reflecting an average 1.6 percent monthly underperformance relative to the rest of US equities.
That means a shareholder would need to be able to lend the most expensive to borrow US equities for at least 13.4 percent annualised fee in order to break even with the decline in share prices relative to easier to borrow shares. At present, the average fee for those securities is only 9.6 percent.
That may be good news from a demand perspective, however, as short sellers have been able to generate positive returns from shorting the most expensive to borrow US equities relative to easy to borrow shares in each month since March. The positive returns to shorting the most expensive to borrow US equities could support an increased willingness to pay up for hard to borrow shares heading into 2020. That paints a very different picture from January and February of this year, when the most expensive to borrow US equities outperformed the rest of US equities by 1.7 percent and 2 percent, respectively.
The tailwinds for short sellers of hard to borrow US equities may result in increased willingness to pay up to borrow shares, however the increased concentration in the shares of relatively few firms is a risk factor for lenders given that the revenues for US equities outside the top 10 are on pace for a fourth consecutive annual decline in revenues.
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