Late last week, Moody's Investors Service published the paper, "Money Market Funds US: Funds Face Bear Market on Flight to Quality." They tell us, "Intense selling pressure across financial markets amid economic disruption from the coronavirus pandemic aggregated significant liquidity in investors' accounts, driving money market fund balances higher by $729 billion since February. Treasury and government funds, deemed to be risk-free, increased assets by $908 billion. Credit-sensitive prime and tax exempt funds lost $180 billion. Consequently we changed our outlook on the global money market fund industry to negative from stable on March 18."
The brief continues, "Credit-sensitive funds experienced outflows and sharp net asset value (NAV) declines, as liquidity for their underlying securities disappeared, initiating a feedback cycle that caused a breakdown in the liquidity of the paper they hold. Conversely, Treasury and government funds, with the least credit risk, experienced enormous inflows and rising NAVs, as yields on the paper they hold approached zero."
Moody's Neal Epstein, Matt Nostro, Robert Callagy and Marc Pinto explain, "The outflow from credit-sensitive funds spurred regulatory intervention, despite money market reforms implemented in 2016 to forestall such circumstances. Whether out of necessity or caution, two sponsors also supported their prime funds, purchasing a combined $4.0 billion of securities, increasing their liquidity. The Fed's Money Market Loan Facility (MMLF) will support funds with weakening credit or liquidity profiles. Assets quickly grew to $53 billion."
On zero rates, they write, "Regulators' extraordinary measures to support market functions and provide liquidity drove money market yields lower. As MMF portfolio yields roll down, we anticipate sponsors and intermediaries will waive fees or absorb fund costs to forestall negative fund yields, reducing MMF revenues during 2020, even though fund assets have increased."
The Moody's piece states, "From February 19, when US equity funds closed at year-to-date highs, US money-market fund (MMF) balances increased by $729 billion to $4.69 trillion. Investors seeking safety preferred Treasury and government money market funds, which increased assets by $908 billion, as opposed to credit-sensitive prime and tax-exempt funds, which lost $180 billion.... The watershed dividing flows between credit-sensitive prime funds and Treasury and government money market funds, which are deemed to be risk-free, illustrates the distinct risk these vehicles bear. Credit-sensitive MMFs are dynamically exposed to both market concerns about the risk of the issuers whose paper they hold and their investors' concerns for fund liquidity and stability. Assets not only flowed out of these funds, but they also experienced reductions in market NAV (MNAV)."
They tell us, "Prime funds, which invest in short-term liabilities such as certificates of deposit (CDs), and unsecured commercial paper (CP) or asset-backed CP (ABCP), principally of banks, face the greater risk. Disruptions in this market may raise these issuers' cost of funding, which could in turn impair their credit strength and establish a feedback cycle: prime MMFs' NAVs would begin to decline as their holdings traded lower, investors would redeem shares, and funds would liquidate holdings and further pressure issuers' funding, amplifying the negative credit signal."
Moody's explains, "In the first week of March, institutional investors increased holdings of prime funds, and the demand caused a brief increase in their MNAVs. During the second week and following, redemptions exceeded $100 billion and MNAVs fell below $1.00 per share.... as investors began to appreciate the magnitude of the growing economic risk."
They add, "Money market fund reforms adopted in 2016 that were intended to stabilize fund assets may have had limited effect under these extreme circumstances. To increase their resilience to potential runs, institutional prime funds are required to transact at their market NAV per share: the logic being that if funds cannot 'break the buck' the incentive to sell in response to NAV fluctuations should be reduced. Further, all fund boards must consider imposing redemption fees or gates if weekly liquid assets decline below 30% of assets. Nonetheless, it appears that investors' concerns about fluctuating value and the use of fees and gates impelled them to redeem shares.... We expect that regulators will once again open the question of prime fund liquidity and stability risks. Paradoxically, the 30% weekly liquid asset threshold may have caused investors to sell quickly to avoid the risk of fees or gates, because the margin above that threshold for some funds was narrowing."
The brief states, "Between March 18-20, whether out of necessity or caution, Bank of New York Mellon and Goldman Sachs each provided financial support to MMFs under rules that govern the purchase of securities by a money market fund's affiliates. According to SEC filings, the Bank of New York Mellon purchased $2.2 billion of securities at fair market value from Dreyfus Cash Management. Subsequently the Bank of New York Mellon Corporation paid the excess of amortized cost over fair market value to the fund. Goldman Sachs Bank USA purchased $1.5 billion of securities from the Goldman Sachs Financial Square Money Market Fund and $0.4 billion from the Goldman Sachs Financial Square Prime Obligations Fund at fair market value." (See our March 23 News, "Goldman, Dreyfus Move to Support Prime MMFs; Fed MMLF Adds Munis.")
Moody's also writes, "On March 18, the Federal Reserve established the MMLF, among a number of other supportive actions, with the Federal Reserve Bank of Boston (FRBB) acting as the lender.... At the end of its first three weeks of operation, the MMLF held $53.1 billion of loans ... helping stabilize both the funds that used it and the market for prime paper, which had suffered from inadequate liquidity. We expect assets of the facility to increase, as the ongoing uncertainty about the future course of the coronavirus and its economic consequences should cause markets to remain volatile. The MMLF is authorized through September 30, 2020, unless the Fed Board extends the program. Nonetheless, we expect prime MMFs will maintain large weekly cash positions, as markets and fund investors remain skittish. Despite the Fed's support programs, liquidity in the short-term market remains tight and spreads remain elevated."
They tell us, "On March 23, to provide further support to MMFs, the FOMC directed its desk for open market operations to conduct overnight reverse repurchase operations (or longer, to accommodate market closures) at an offering rate of 0.00%. These operations made the Fed's available supply of Treasury securities accessible to MMFs. One goal was to prevent marketplace scarcity (in the face of high demand for Treasury securities) from driving benchmark yields into negative territory.... Because the Fed expects to maintain its zero-bounded target range for Fed funds (announced on March 15) until the economy has strengthened, we anticipate fund sponsors will be forced to waive or absorb costs for at least the balance of 2020. An additional 10 basis point waiver or cost reduction on $3.6 trillion government and Treasury fund assets would lead to $3.6 billion lower fees."
Finally, they write, "For Treasury and government funds, large inflows in the face of declining asset yields reduce the margin between the yield of a fund's portfolio and its expense ratio. As assets balloon ... fund managers must acquire securities at near-zero yields, driving these funds' yields lower.... If a fund's portfolio yield is lower than its expense ratio, the fund will lose money on every additional dollar it takes in, unless the sponsor (and sales intermediaries) agrees to waive fees or absorb operating costs.... On March 31, Fidelity announced it would 'soft close' three large MMFs that invest in US Treasury securities, after they became a haven for investors fleeing market volatility."
