S&P recently published a study entitled, "California County And Local Government Investment Pool Managers Position Themselves For Growth, But At What Cost? which says, "Standard & Poor's Ratings Services' latest annual survey of California investment pool managers reveals that although pool participants see interest rate increases as the greatest portfolio risk, they are allowing their portfolio duration (a measure of sensitivity to interest rate movement) to increase, thus making their investments more susceptible to that very risk. We interpret this to mean that investment pool managers see decent growth prospects and are seeking marginally higher investment returns rather than flight to liquidity."
The study explains, "California's ongoing budget and general fund cash deficits have underscored the importance of cash management at the local agency level throughout the state, in our view. School districts in particular, which depend considerably on state aid, have seen a growing portion of their state-aid revenue deferred from one fiscal year to the next. These deferrals add to the challenge of cash management. Even when the state's budget is not distressed, a local government's cash outflows commonly exceed its inflows during certain periods of the year. To bridge these cash deficits, local agencies can, in the manner of states, use internal cash resources or borrow on a short-term basis from the capital markets by issuing tax and revenue anticipation notes (TRANs), many of which we rate. Although not a replacement for revenue lost because of state-aid reductions or economic weakness, TRANs help local agencies manage relatively predictable mismatches between anticipated cash receipts and cash disbursements."
S&P continues, "Local agencies in California frequently invest idle capital and operating funds and proceeds from TRAN issues in their respective local county investment pools (LCIPs). Some local agencies and numerous LCIPs themselves invest in several statewide local government investment pools (LGIPs). In either case, the statutory goal for the investing agencies or LCIPs is maintaining the safety and liquidity of their investments. In addition, with limited revenue raising flexibility in California, investments are an important source of income, albeit usually smaller (frequently 5% or less of general fund revenue) than primary revenue (such as property tax). During the past few years we've seen investment incomes decline, consistent with the Federal Open Market Committee's continuation of low interest rates since December 2008, which in turn reduced the yields on short-term Treasury holdings. In our ratings analysis for TRANs and long-term debt issued by many of the counties and local agencies, we consider exposure to LCIPs and LGIPs as credit factors. This is because LCIPs hold and invest cash proceeds (which are operating funds) on behalf of the local agencies and because many local agencies -- and all school districts – invest other idle operating and capital funds with their LCIPs."
The study adds, "We note that macroeconomic risks to California investment pools during the next year could include: Uncertainty regarding the EU's austerity measures, which could keep the markets depressed for the near term; The U.S. presidential election, which has historically shown more favoritism to equity markets rather than to bond markets; and A lack of any emerging or growing sectors in the economy that could lead to any significant productivity growth, although that lack could keep the bond markets a safe haven."
In other news, consulting firm Treasury Strategies recently submitted a letter to the SEC's Mary Schapiro taking aim at a recent Moody's commentary. The letter says, "We are pleased to submit for your review the enclosed letter to Moody's Investors Service. The letter is our rebuttal to the Moody's report, "Weekly Credit Outlook: US Money Market Funds," which was published on July 2, 2012. Our letter presents a fact-based and logical challenge to Moody's conclusions regarding the impact of additional regulations to Money Market Funds that are currently under consideration by the US Securities and Exchange Commission. Those regulations include: Capital Buffer, Floating NAV, and Redemption Restrictions. The gravity of these potential regulations and magnitude of their impact underlines the importance of presenting the facts accurately, in the proper context and without spin. We are compelled to distribute the enclosed letter to you as it is of material importance during your deliberations on additional Money Market Fund regulations."
Treasury Strategies' letter to Moody's Henry Shilling explains, "In response to your comments regarding US Money Market Funds ... Treasury Strategies, Inc. (TSI) would like to contribute the following information for your consideration.... As we have reflected upon your comments regarding the SEC's money market fund (MMF) proposals, we believe it is necessary to consider the secondary effects of these proposals when discussing the credit impacts to investors and fund sponsors. We believe the impacts are negative to both fund investors and fund sponsors."
It adds, "Some specific points for consideration include: Imposing a capital buffer will have far more negative consequences to investors and fund sponsors: 1) by attracting more risk averse investors who are more likely to run at the first sign of trouble, and 2) in terms of pushing managers to take on more portfolio risk to compensate for the cost of the additional capital. Many more investors would leave MMFs under a floating NAV. This exit would greatly reduce the size of a fund and destroy the economies of scale that are crucial to the business. The report's view of sponsor support can be very misleading to readers. The study and the SEC Chairman's remarks both toss around numbers with neither substantiation nor context. Because the report does not name these "problem" funds, a dispassionate and objective third-party analysis is impossible."