The trying days continue for US money market funds.
They’re still attracting some haven-chasers for now, but the combination of complying with the SEC’s Rule 2a-7, increased credit risk from Europe and the endless low interest rate environment is making it difficult for them to cover costs.
Here’s a newly updated chart from Credit Suisse showing the razor-thin margins of the funds as of the end of October:
Credit Suisse explain how complying with an amended 2a-7 (so modified to address the problems of 2008 when the Reserve Primary Fund broke the buck) has further shrunk their profitability since it took effect last year; here’s one primer. The new version of the rule requires these funds to include a higher share of cash and government securities that can be quickly converted to cash. It also limits how much second-tier commercial paper they can hold and has forced them to reduce the maturity of their holdings.
Perhaps yet another example of pro-cyclical policy that is sensible for benign times – but that also makes life more difficult for the institutions being regulated before calmer times return.
But a few other things are happening here. The Fed’s promise to keep rates “exceptionally low” through 2013 means the basic business model of these funds will remain challenging for a while, and some of them have now begun waiving fees “in order to avoid a situation in which investors realise negative interest rates on their savings,” writes Credit Suisse.
These investors, of course, have other options that would have been less attractive in the past. No longer, as Credit Suisse explains:
With near-zero interest rates for cash and near-cash alternatives, the opportunity cost of parking money in an FDIC-insured savings account as opposed to an MMF becomes practically insignificant. Traditionally, retail money funds have enjoyed a relatively stable shareholder base, since households are more interested in NAV stability than the return on their assets (i.e., they don’t necessarily withdraw cash from MMFs when rates fall as would an institutional account). But as Exhibit 8 illustrates, in this ultra-low interest rate environment, cash is migrating from money funds, and a significant portion of the outflow is going into savings accounts at depository institutions. Investment companies, however, are seeing some of the MMF outflow being redirected up the risk chain – to bond mutual funds.
And the problem is compounded by the fact that even as these funds continue withdrawing from European banks (more on which in a second), the availability of first-tier commercial paper elsewhere is falling (though there’s evidence it has rebounded very recently, especially for non-financials, and might increase in response to higher demand):
Another possibility, floated this week by Fitch, is for these funds to increase their purchases of second-tier paper, whose amount outstanding has actually been growing. This might help at the margins given how little of this paper these funds now own — but again, the new regulatory constraints have imposed tighter limits on how much they can buy, and Tier 2 paper remains a small part of the overall commercial paper universe.
As for these funds exiting Europe, a new report from Fitch Ratings includes the trend through October, and certainly the emigration has increased since:
The Fitch Ratings report covers the ten largest prime money market funds, which have fewer restrictions on what they can buy than Treasuries-only or government-only funds. And yet:
Over the past few months, MMFs have increased their holdings of short-term U.S. Treasury notes. Starting from negligible levels in 2007, Treasury exposure has increased steadily and now represents 10% of total assets of the MMFs sampled (see “Increasing Exposure to Treasurys and Agencies Over Recent Months” table). MMF holdings of short-term agency debt has also risen in recent months, up 33% on a dollar basis since month-end May.
And of particular note has been the shortening of the maturities in their French bank holdings:
The MMFs sampled continued to reduce the maturity profile of their CD exposure to French banks (see the “Shortening Maturities for French Banks” chart). As of month-end October, more than half (54%) of MMF exposure to French bank CDs resided in the shortest maturity bucket (seven days or fewer), up from roughly 7% in month-end June. There has been a corresponding shift in French bank CD maturities out of the longest term bucket (61 days or more), which now represent less than 5% of French bank CDs, down from over 50% as of month-end June. The maturity profile of MMF exposure to U.K. and Netherlands bank CDs were generally stable relative to the prior reporting period.
Credit Suisse note in the usual place.
The emigration of the money market funds – FT Alphaville