On Friday, Federated Investors hosted its second quarter earnings conference call and, as is usually the case, President & CEO Chris Donahue and Taxable Money Market CIO Debbie Cunningham commented extensively on various issues involving money market mutual funds Donahue said, "On the regulatory front, money funds continue to be an active topic of discussion. Based on comments from the SEC, and the FSOC, the regulators believe that further changes should be considered and are under review. We are unable to make any predictions on any particular outcome or a particular timeline. We do note, however, that the industry, issuers, and investors in money funds are opposed to a fluctuating NAV. In our view, there is no evidence that a floating NAV would positively impact investor redemption patterns or improve the resiliency of money funds. In fact, we believe fluctuating NAVs would have the opposite effect."
He continued, "Capital buffers are not necessarily responsive to the severe liquidity crisis that negatively impacted money funds and other investors in 2008. Our initial reaction to ideas like the Squam Lake capital buffer, before the results of the voluminous studies necessary to adequately research such a concept with this level of complexity, is that it's probably not a practical solution. One outcome could end up being to compress or even eliminate the spread between Prime and Government fund yields which would be just another way of ending Prime funds which is not the goal of the entire operation."
Donahue explains, "We believe that money funds were meaningfully and sufficiently strengthened by last year's extensive revisions to 2a-7 and we're seeing those changes help now as we deal with the noise created around the perception of risk in Prime money funds from European bank exposure. We remain favorably disposed to improvements that would enhance the resiliency of money funds by addressing the primary issue faced during the financial crisis namely a market-wide liquidity crunch."
On the earnings call, Federated CFO Tom Donahue added, "Conditions for money market funds continued to be challenging in the second quarter and into the third quarter. Money fund yield waivers reduced pre-tax income by $19.4 million for the quarter compared to $13.1 million in the prior quarter.... Yields decreased during the quarter which led to waivers exceeding the April calculation, based on then current market conditions. Yields have generally trended lower as the market deals with the debt ceiling issue and concerns over European debt. Based on recent market conditions and asset levels, these waivers could reduce income by approximately $23 million in Q3 for Federated. More recently we've seen an uptick in rates for Repo and T-Bills which impacted waiver levels in the government funds. We expect these rates to move off of the extremely low levels in the first couple weeks of July as we move toward some resolution of the debt ceiling issue. We have seen some upward movement over the last couple of days. Looking forward, we estimate that gaining 10 basis points in gross yields will likely reduce the impact of these waivers by about 1/3 from the current levels and a 25 basis point increase would reduce the impact by about 2/3."
Cunningham explained on the call, "From a European bank perspective, a couple things have happened [recently]. The stress tests for those banks by the EU have been completed with some amount of success.... The package for Greek debt restructuring has also been reached, and although it is not a quick fix in the marketplace it has received fairly good market impact. And by that, I look at the spreads that we see in European banks and again we use 22 different banks, high quality banks within the Euro zone.... These banks have stayed the same from a spread perspective in the marketplace from widening maybe two to three basis points. From a Federated prime fund exposure, we have currently and are still maintaining somewhere in the neighborhood between 40 and 45 percent of our prime funds exposure to these European banks. We have no direct exposures to the Greek banks. But the European banks that we use do have some exposure on a secondary basis to the Sovereign Greek nation. We continue to be comfortable with the ownership of these banks. We post that on our website every two weeks so you can get the most quarterly information there when you're looking for it."
She continued, "The third item is the debt ceiling issue and concerns in the market place about default, a downgrade and ... liquidity in the marketplace. From a default perspective, we think this is a very remote likelihood. It would require, if the actually did happen, action by the fund's board of directors. We would need make, as an advisor, recommendation to the board of directors based on the underlying credit quality of the nation itself, market evaluation, the fact that this is a in insolvency issue but rather a willingness to pay and a political theater issue. At this point, if it had to ... our recommendation would be to maintain the ownership of these technically defaulted instruments at that point. Again, thinking this is a very remote possibility."
Cunningham said, "We think [the possibility of a downgrade] is less remote, obviously as the default. But still we don't think this is probable. The first thing to note is the [possible] downgrade is ... for long term ratings only, not short term ratings. So nothing would be affected from the short term ratings perspective for the securities that are held within money market funds.... Treasury securities are still the largest with the most volume, with the most liquid, highest quality instrument in the world ... and certainly not surpassed by bank deposits, where in fact the backing of those banks comes from the U.S Government. These would still maintain their liquidity in the market place, but with a price volatility that would be a little more ... than what it has been in the past."
Finally, she added, "From a Federated fund perspective, despite the outlook for negative potential downgrade for the long term ratings for the US government debt, the Federated money market fund has been affirmed with their AAA ratings. So even if the U.S. debt was downgraded to AA, AA+, AA- whatever would happen to be, at this point the AAA ratings for Federated funds would be maintained.... We have positioned ourselves well to what we think is a second half steepening of the yield curve and it provides ourselves with a lot comfort to the shareholders in the context of liquidity that might be needed."
