Fitch Ratings just released a study of the portfolios of the 19 U.S. prime money market mutual funds rated 'AAA/V1+' by the agency, which account for nearly $600 billion, or almost half of all prime money fund assets. The report, entitled, "U.S. Prime Money Market Funds: Managing Portfolio Composition to Address Credit and Liquidity Risks," "summarizes the trends in credit quality and liquidity of these funds over the last nine months, including: General flight to quality resulting in significantly increased allocation to U.S. Treasury and government agency securities.... A reduced universe of eligible investments given credit deterioration of certain issuers and consolidation among others. [R]educed exposure to ABCP programs sponsored by banks and financial institutions. A preference for foreign bank products versus U.S. bank products in the form of certificates of deposits (CDs), bank notes, and time deposits (TDs). Decline in fund yields given the low interest rate environment.
Fitch says on background, "Prime money market funds faced unprecedented credit and liquidity stress during the second half of 2008, stemming from the default or credit deterioration of a number of major financial institutions and the net asset value impairment of one of the largest U.S. prime money market funds. Challenged by these events, prime money market funds have sought to preserve a high level of portfolio liquidity to be better positioned to withstand the potential risk of future increased redemptions while reducing direct and indirect exposure to financial institutions expected to face additional pressure. In addition, money market funds decreased their exposure to insurance companies by putting back funding agreements and allowing maturing notes to roll off."
They continue, "From year-end 2008 to the end of May 2009, U.S. prime money market funds have steadily reduced allocation to corporate securities and increased investments in government-issued or government-guaranteed securities. U.S. government securities have acted as a safe haven for investors seeking to avoid the credit risk of corporate/financial securities while serving to stabilize fund net asset values.... [A]llocation to corporate unsecured notes and ABCP decreased to approximately 25% of total assets in May 2009 from approximately 40% of total assets at the end of 2008.... ABCP holdings ... decreased to 10% of total assets of U.S. prime money market funds in May 2009 from 22.3% of total assets at the end of 2008."
The report adds, "While a number of U.S. prime money market funds invested in commercial paper and notes issued by financial institutions under the terms of TLGP [the FDIC's Temporary Liquidity Guaranty Program], Fitch identified 12 of the 19 funds it rates that did not purchased TLGP paper during the observed reporting periods. This may be explained by the untested nature of the TLGP facility and uncertainty as to the settlement/redemption procedures for such securities in the event of default of an underlying issuer. The FDIC has guaranteed these issues but there was concern by a number of market participants as to the ability of the FDIC to step in and provide immediate repayment since the FDIC is not a regulator of holding companies."
Fitch continues, "Historically, U.S. prime money market funds have allocated a significant portion of their portfolios to various bank products, including CDs, bank notes, and TDs.... U.S. prime money market funds increased their investments in these types of securities to 44.4% in May 2009 from 35.3% of total assets as of Dec. 31, 2008.... Driving the overall increase in U.S. prime money market funds' investments in bank products is a continued preference for exposure to non-U.S. bank holdings versus U.S. bank holdings. Specifically, holdings of non-U.S. bank CDs increased to 34% of total assets in May 2009 from 25.7% as of Dec. 31, 2008.... [C]ertain money market funds may already have reached their internal single issuer or counterparty limits on individual U.S. financial institutions with strong stand-alone ratings."
"Money market funds remain focused on managing liquidity risk through the maintenance of overnight investments in repurchase agreements, TDs, and shares of other money market funds, among others. Aggregate exposure to such sources of overnight liquidity has remained at approximately 15% of total assets over the last six months.... Individual fund investments in overnight instruments varied from under 5% of total assets in two funds to close to 50% of total assets in one fund. The variance in overnight allocations may be explained by the nature of individual fund's shareholder bases and expected future redemption activities," says the study.
Finally, Fitch says, "The portfolio rebalancings undertaken by prime money market funds over the last six to nine months are largely viewed positively, reducing credit and liquidity risks. These actions, in combination with the presence of meaningful support facilities from the U.S. government, have served to stabilize investor outflows and leave funds well positioned to withstand further credit and liquidity stress.... Despite negative economic consequences of the prolonged low interest rate environment on fund economics, fund advisors appear primarily focused on preserving stability of principal and liquidity at the present time. If current trends persist, Fitch would expect the likelihood of fund closure and asset consolidation to increase."
