Today, we excerpt the second half of our article, "U.S. Bancorp Sticks With First American Funds," which interviews Joe Ulrey and Jim Palmer. MFI: What are the funds buying? Palmer: Certainly repo is a large component of our Treasury Obligations and Government Obligations funds. It's difficult to get away from that, especially when you consider how low yields are in 90-day T-Bills or in 90-day Discount Notes. In that high-quality liquid space, it is much harder to find attractive alternatives to repo. We are seeking longer dated floaters and concentrating more on U.S. Treasury securities.
We have invested more of our Prime and Government fund assets in U.S. Treasury notes as Treasuries have become a more valuable asset class for funds for a variety of reasons. First, we can include Treasuries in our daily and weekly liquidity asset calculations.... Second, with rates so low and the spreads on corporate, bank and especially in agency securities being so thin, the relative value of Treasuries has gone up from a yield perspective as well. As a result, we have the ability to improve the risk profile of our funds without greatly sacrificing yield.
MFI: Are there any other supply developments? Palmer: We're definitely participating more in the municipal market through daily and weekly VRDNs. VRDNs can offer incremental return over Repo, CDs, and CP, with daily and weekly liquidity. Money market funds and other investors will perhaps find more ways to move more cash out of repos and into other investments which may help correct the demand/supply imbalance. Also, some of the collateral issues may resolve themselves over time.
MFI: How long can we stay low? Palmer: We can stay low as long as the Fed feels we need to stay here and U.S. economic growth remains anemic. Our forecast is for the Fed to remain on hold through 2011. The recent public comments from several Fed presidents have suggested a growing disagreement within the Fed about the risk of completing QE2 as well as keeping the Fed Funds rate targeted in the 0-25 basis point range. But we believe the key decision makers remain firmly in the camp of keeping policy steady, given their view that the economy is still relatively weak and inflation is still well contained. Ultimately, we feel these key decision makers will win the day and policy will remain accommodative.
MFI: What are your customers concerned about these days? Palmer: I'd say with so much transparency in the industry, it's really rare for any customer to express concern about the current investments in the First American Funds. What we have now is a much more informed investor base. They are asking broader questions -- what's happening in Europe, how do the terrible events in Japan affect the money markets, and primarily, when do we think the Fed will raise interest rates? This is where we like to have our credit analysts or portfolio management team step in and provide additional commentary, and that comes through either our website or conference calls with clients. But I would say that for the last year, the most common questions have revolved around the low yield environment and 'when can we expect to see higher yields on our cash?'
MFI: How are fee waivers impacting the business? Ulrey: Fee waivers are quite painful to us as a business line, and we're feeling the same pain as all money funds out there in this waiver environment. However, U.S. Bank is well-positioned to handle a downturn in one of its divisions. Fortunately, the asset management business overall does remain profitable to the bank and represents a core product to the client base. U.S. Bank remains committed to this product. This investment space represents a solid anchor product for our clients. I can't stress that enough.
MFI: What are your thoughts on the future of money funds? Ulrey: We did not comment [on the PWG report] since we were going through a lot of the changes with Nuveen at the time, but we do have a perspective on the future of this business. We believe the money market business is here to stay and will remain a $1 NAV product. There is $2.7 trillion sitting out in money fund investments patiently waiting for yields to increase one of these days, so the clients do like the product as it's structured today. It's an investment that provides principal preservation, daily liquidity and high-quality assets.
Speaking to the PWG and the regulatory front, we believe the SEC has done a great job with the WAL, WAM and overnight liquidity changes. Also implementing additional and more appropriate disclosure requirements was a positive change. These alone have gone a long way to button up any potential vulnerabilities in money market funds. PWG can, hopefully, further improve on this foundation. However, we believe that floating NAV would not have stopped the run on assets, and that it is not a viable alternative. Some of the other options out there, such as liquidity facilities or capital reserve requirements, could be possible options. We'll continue to stay tuned, provide input, analyze the ideas and see where the industry goes.
MFI: Can you talk about the profile of the investor base? Ulrey: The vast majority of the clients in our funds are core clients of U.S. Bank. They come to invest in First American Funds through services the bank provides. Whether they're buying corporate trust services or institutional trust and custody services, money market funds are secondary. I think that's a huge advantage for us. You've got investment liquidity, but you also have your investor base liquidity. And we have a very diversified investor base. We have direct relationships with these clients through U.S. Bank, which is huge. We can pick up the phone and talk to them directly about what's going on in our funds.
