ESM, Bevill Failures Taking Toll on Other Regional Dealers; Primary Government Securities Firms Review Business, Cut off Some Smaller Companies in Wake of Bankruptcies

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WASHINGTON -- Primary government securities dealers are cutting off regional dealers and reviewing business relationships as a result of the recent failures of E.S.M. Government Securities Inc. and Bevill, Bresler & Schulman Inc., traders and executives in the industry said.

The extend to which relationships are being severed differs among the primary dealers, but there has been a strong movement to shorten the maturities of all forward commitments, sources said. Those interviewed said a decline in liquidity in the Treasury market is not yet clear but is considered a distinct possibility.

"The market could have digested the failure of one firm, but not two, as has happened," one bank regulator said. Most people regarded Bevill as "reasonably well-capitalized," he said, and this makes the ongoing credit reviews particularly urgent.

"Only two primary dealers will do business with regional firms for anything longer [in maturity] than five business days. And they don't even want to hear from you unless you've got at least $50 million in capital," said the head trader of government mortgage-backed securities at a primary dealer.

A trader at another primary dealer said his firm was stressing a "know-your-customer" standard rather than relying on a set level of capital for a regional dealer. The allegations of fraud in the E.S.M failure demonstrated that financial statements purporting to show adequate capital are no guarantee of creditworthiness, he said.

An official in charge of the repurchase agreement desk at another primary firm said, "Every major dealer who wants to keep his socks in his shoes is resetting and recasting credit lines. Marketwide, people are being very circumspect with their customer lists."

Repurchase agreements, or repos, are contracts to sell securities with simultaneous agreements to buy them back. The party selling the securities is actually getting a collateralized loan. The flexibility and complexity of some repo trading leave the instrument open for abuse through speculative activity and fraud. …