Fitch on Callable Commercial Paper
Last week, Fitch Ratings released an update entitled, "MMFs Explore Callable Commercial Paper in Value", which said, "Money market funds (MMFs) are slowly increasing exposure to a relatively new short-term instrument -- callable commercial paper (CP), according to Fitch Ratings. MMFs are exploring callable CP as a way to add additional yield and diversification to portfolios, as well as in response to banks' reduced appetite for providing back-up liquidity to traditional municipal securities. The exceptionally low-yield environment in the money markets is encouraging MMFs to seek new opportunities to offer competitive yields to their investors. Variable rate demand notes (VRDNs), which have one- or seven-day put options, traditionally comprise a majority of municipal MMFs' portfolios. However, VRDNs have been in short supply recently and have seen additional strong demand from prime MMFs, pushing VRDN yields lower. To compensate, tax-exempt MMFs have begun to consider newer instruments that offer longer durations and higher yields, such as callable CP. Banks that previously provided back-up liquidity to VRDNs have grown more reluctant to do so because of increased costs associated with Basel III's restrictions on commitments that come due in less than 30 days. Callable CP usually has maturities longer than 30 days but is expected to be called by the issuer prior to the 30 day mark, allowing the bank providing support to avoid incurring higher costs. Due to their novelty, callable commercial paper securities have the potential to yield more than traditional VRDNs and commercial paper. Fitch recognizes that while these relatively new securities have the potential of higher yields, the extended effective final maturities that accompany callable CP, disregarding the call option, will impact MMFs' weighted average lives (WAL). MMFs are subject to a 120 day regulatory maximum restriction on overall portfolio WAL. We believe the practice thus far of MMFs looking to the final maturity date of these securities for liquidity purposes is appropriately conservative for risk-averse vehicles like MMFs, especially those rated 'AAAmmf.' Additional detail is available in our report, "Callable CP: Short-Term Credit Market Primer"."
