Nearly one-third of money market funds in South Africa had some exposure to African Bank Investments, which collapsed in August and which allegedly caused some S.A. money funds to "break the buck". But in a report released Tuesday, Fitch Ratings expects the effect of the African Bank collapse on South African money market funds to be limited. "Fifteen of the 43 money market funds active in South Africa had exposure to the troubled African Bank, which accounted for 1.3% of the industry's total assets of ZAR270bn as of end-August 2014, according to the Financial Services Board. Some MMFs absorbed the cost of the write-down from the bail-in of African Bank through available income, as approved by the FSB. In other cases, the write-down cost exceeded the income that could be applied against it, resulting in a capital loss. Fitch downgraded those MMFs that suffered a capital loss as a result of African Bank exposure. We placed all the funds with African Bank exposure that we rate on Rating Watch Negative," writes Fitch. (See our Aug. 26 Link of the Day, "FT: South African MMFs Break the Buck", and our Sept. 24 Link of the Day, "Fitch on South African MMFs".")
Fitch adds that outflows from MMFs with African Bank exposure were less severe than expected. "At an industry level, the outflows from funds with African Bank exposure were broadly offset by inflows to other funds, notably corporate MMFs, which typically invest solely in South Africa's major banks. We believe the combination of continued retail investor outflows, driven by low real interest rates, and events at African Bank, will lead to the South African MMF investor base becoming more corporate. We forecast a continued increase in South African corporate cash on balance sheets."
They add, "South African MMFs would not qualify as 'money market funds' under applicable US or European regulation. These funds are materially more concentrated than permissible under SEC Rule 2a-7 (US) or the UCITS framework (Europe), with lower primary liquidity. As a result, Fitch rates these funds applying its Global Bond Fund criteria rather than its Money Market Fund criteria. Furthermore, South African MMFs are highly unlikely to achieve a 'AAA' National Fund Credit Rating."
In other news, Wells Capital's David Sylvester writes in his latest "Portfolio Manager Commentary," "The money market space continues to wrestle with a limited selection of eligible high-quality investments. Fundamental factors and changes to the regulations affecting the issuers of short-term debt have combined to lead to a curtailed supply, exacerbating the already-low interest-rate environment." Sylvester and his team look at the effects across the various sectors of the industry in their latest update.
On the "Prime Sector," Sylvester writes, "There are solid fundamental reasons for the decline in the supply of high-quality money market instruments. Balance sheets are in great shape, and corporate and government issuers alike have been taking advantage of the lowest interest rates in 50 years to extend the term of their debt. But new banking regulations like the Basel III liquidity coverage ratio (LCR) are serving to further suppress the issuance of short-term instruments by financial institutions. The LCR requires banks to hold an amount of high-quality liquid assets, such as cash and government securities, to cover their net cash outflows over a 30-day period in a stressed scenario. One way banks might comply with the LCR would be to issue only long-term debt or equity securities. While this might be LCR-friendly, not every asset should be financed long term, and this approach might not provide the optimal financing mix."
The update continues, "If some short-term funding is necessary for a large financial institution -- and it is -- one key to managing the LCR is to keep short-term debt from rolling down into the 30-day and shorter LCR bucket. This could be accomplished by adding an option whereby the issuer may call the security before its maturity gets to 30 days. Callable bonds aren't particularly new or unusual, and these securities generally carry a yield premium over a noncallable issue, but we haven't been enthralled with this structure because the premium paid to the investors has often been below the intrinsic value of the call option on a standalone basis."
Wells explains, "More recently, we have seen issuance of financial commercial paper and Yankee certificates of deposit with both a call and a put option. The holder has the right to put the security back to the issuer with a specific notice period, while the issuer has the option to call the security after it has been put back or soon before it enters the 30-day LCR bucket. If priced appropriately, this structure seems to offer a little something for all parties."
They add, "We believe that as we continue with the implementation of the LCR and other types of banking regulations, we will see an increase in the issuance of securities designed with regulatory compliance in mind. While the current rate structure argues against a surge in short-term debt issuance, more complete development of the market for these types of instruments could be a welcome feature of a more normal interest rate environment."
Finally, on the "Government Sector," Wells' Sylvester explains, "First, the single most dominant factor in money markets is the Fed's big balance sheet, specifically all the excess reserves on the liability side of it. Few need to borrow, and those who do (like the U.S. Treasury) find a line of willing lenders. The Fed's balance sheet is expected to stop growing in a month, with the end of QE3, and then to stay stable until interest rates rise, at which point it should begin a long, slow runoff. So, although the environment shouldn't get any worse, it will stay bad for a long while."
