Last week was another busy one in the money markets, as Moody's downgraded some of the short-term debt of Citi and BofA, the Federal Reserve declined to reduce its IOER rate but announced "Operation Twist," and of course Europe continued to be an area of concern. On Wednesday, Moody's Investors Service downgraded Bank of America Corp. to P-2 (but left subsidiary Bank of America N.A. at P-1) and downgraded Citigroup to P-2 (but left Citibank at Prime-1). While these two banks are among the largest issuers and dealers in the money markets, J.P. Morgan Securities writes, "The impact of US banks' downgrades on money funds should be fairly minimal. This is because money fund exposure to US banks is only 15% of their total bank portfolio."
JPM's weekly "Short-Term Fixed Income" explains, "[T]he impact from a 2a-7 perspective is ... quite small, as technically they are still considered Tier 1 and not Tier 2 issuers. This is because they continue to hold '1' ratings from both S&P and Fitch (A-1/P-2/F-1).... [W]e think there may be some impact to Moody's rated money funds (both prime and government), which represent slightly over half of the money fund market. While Moody's new money fund methodology utilizes a more "holistic" approach ... we think the downgrade of BAC and C to P-2 could impact the funds from a repo perspective.... [O]ur best interpretation of the above is that funds could be limited to only O/N GC repo investment with P-2 rated counterparties, although they may continue to use the look through treatment under Rule 2a-7. However, as of August month-end, we estimate there were only $15bn of non-traditional repo and $1bn of term government repo between BAC and C."
In other news, on Friday, Fitch Ratings echoed other recent evidence indicating that money funds continue to gradually reduce their exposure to European holdings, particularly French banks. In a release entitled, "U.S. Money Fund Exposure to European Banks Declines Further," Fitch says, "European bank exposure [as of 8/31/11] currently represents 42.1% of total MMF holdings within Fitch's sample, down from 47.2% as of month-end July. [Note that unlike Crane Data, Fitch counts Treasury and Government-backed repo in their totals.] On a dollar basis, MMF exposure to European banks declined by 8% since month-end July and by 27% since month-end May."
Fitch's Robert Grossman comments, "Declining exposure to core European banks is being significantly offset by increasing investment in Australian, Canadian, Japanese and Nordic bank instruments." The release adds, "Fitch's analysis also found that the maturity profile of MMF CD exposures to European banks declined in some countries. As of month-end August, approximately 28% of MMF exposure to French bank CDs was in the shortest maturity bucket of seven days or fewer, a four-fold increase in this bucket relative to month-end June. Fitch based its sample on the 10 largest U.S. prime MMFs with total exposure of $676 billion as of Aug. 31, 2011. This figure represents approximately 45% of the $1.49 trillion in total U.S. prime MMF assets."
Finally, The Wall Street Journal has positive news for once in its "Fed's 'Twist' May Help Money-Market Funds". It says, "Money-market funds, often regarded as among the safest global investment vehicles, could soon get some much-needed relief thanks to the Federal Reserve's latest stimulus plan.... The Fed's new accommodation effort, dubbed "Operation Twist," may lead to better results. The central bank's plan involves selling shorter-dated Treasurys over the next nine months, a move that is designed to push short-term debt prices lower and force yields, which move inversely to prices, higher. Because money-market funds rely so heavily on short-term Treasury yields to generate returns, a boost of even one or two hundredths of a percentage point is a boon to managers who have been accepting bare-minimum interest all summer."
