BlackRock’s ETF Lending Cap Will Weigh On Revenue

Growing concerns among its clients forced BlackRock (NYSE:BLK) to recently announce a 50% security lending limit for each of its iShares exchange traded funds (ETFs). ^[1] Late last year, clients started raising objections to the asset management giant’s unchecked security lending policy, as it brought in significant counter-party risk to their investments. ^[2] The securities lending business is an essential source of revenue for asset managers like BlackRock and its competitors including State Street (NYSE:STT) and Legg Mason (NYSE:LM), driven by a high demand in the global market.

We maintain a $217 price estimate for BlackRock, which is nearly 30% above its current market price – something we attribute to the pessimism prevalent in the stock market towards stocks of financial firms.

See our complete analysis of BlackRock’s stock here

Late last year, reports suggested that some of BlackRock’s iShares ETFs had lent out more than 90% of the securities they held, with the average figure being around 92%. Clients did not take this news very well, considering the fact that such a large proportion of the securities being loaned presented additional counter-party risks to their portfolio. Clearly BlackRock’s policy of returning 60% of the security lending revenue back to the fund did not provide the clients with sufficient returns for the added risk – something which was further heightened by the weak global economic scenario.

BlackRock finally gave in to the pressure from its clients, announcing its decision to limit lending to 50% of the total value of securities that the fund holds. The company, though, maintains that it has the ability to lend out more – something which can be read as an option to stretch this limit in the future if revenues take a bigger hit from the new cap than what is anticipated.

So how much will the revenues be hit by? And how much of BlackRock’s overall value will this in-turn affect?

Historically, security lending for a particular ETF has added anything between 1 basis point and 15 basis points (0.01% to 0.15% of the fund’s value) to the fund’s revenue. ^[2] Considering the fact that the highest earning ETFs which roped in 0.15% of the fund’s value in additional revenue also lent out the most securities – up to 95% – would mean that after the new limit, the range of revenue from lending will be 0.08% of the fund’s value at most.

An assumption that before the limit, average additional returns were around a ballpark figure of 0.07% would make returns around 0.04% the likely average after the limit is imposed. This implies a reduction in revenues equal to 0.03% of total ETF value for BlackRock ETF. Making this change to the chart above shaves off nearly $6 from our $217 price estimate for BlackRock.

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1. BlackRock imposes 50% cap on ETF security lending, Citywire, June 20 2012 [↩]
2. ETF securities lending comes under scrutiny for collateral risk, Citywire, Nov 11 2011 [↩] [↩]