News Archives: June, 2008

Money funds holdings of commercial paper continued declining in the latest month, falling to 25.0% of taxable holdings. Repurchase agreements also dropped sharply in April, the latest month's statistics available from the Investment Company Institute, to 19.2%. U.S. Government agency securities increased, from 10.6% to 11.7%, on the month, while most other holdings remained relatively stable. T-Bills and Treasury securities continued growing; they now represent 9.7% of holdings.

Money market mutual funds held $736.4 billion (25.0%) in CP at the end of April, $567.0 billion (19.2%) in repo, $344.3 billion (11.7%) in Govt agencies, $321.4 billion (10.9%) in corporate notes, $281.8 billion (9.6%) in CDs, $212.7 billion (7.2%) in T-bills, $159.8 billion (5.4%) in Eurodollar CDs, $155.9 billion (5.3%) in "Other" securities (which includes bankers' acceptances and cash reserves), $95.2 billion (3.2%) in bank notes, and $72.5 billion (2.5%) in other Treasury securities.

Though money funds' CP holdings declined in the month, they still increased by $71.6 billion over the past year. But their percentage of total portfolios fell, from 32.3% to 25.0%. Money funds now own approximately 42% of the $1.758 trillion commercial paper market. Asset-backed CP accounts for about 44% of the overall CP market, as of April 2008 (according to the Federal Reserve Board's seasonally adjusted CP Supply totals).

Corporate notes rebounded slightly in April, rising from 10.8% to 10.9%, but they too suffered a steep decline from their year ago level (16.4%). Government agency securities increased their percentage the most, rising from 5.9% to 11.7%. T-Bills too took a big leap, rising from 3.1% to 7.2% over the year through April 2008.

Money fund assets fell $20.45 billion in the latest week, to $3.455 trillion. Over the past three weeks, assets have dropped by $75.2 billion. The Investment Company Institute's weekly data series shows retail assets dropping sharply, an unusual occurrence. Individuals withdrew $13.45 billion, to $1.208 trillion, while institutional investors withdrew $7.01 billion to $2.248 trillion.

Over the past 4 weeks, money fund assets have declined by about $57 billion. ICI also released their monthly asset totals for May 2008 yesterday, which showed money fund totals gaining $52 billion. Year-to-date, money fund assets have increased by $300.5 billion, or 9.6%. Over 52 weeks, money fund assets have grown by $909 billion, or 35.8%.

Outflows were likely caused by retail investors moving back into stocks, allocating cash for vacation spending, and normal month-end outflows. Retail funds also were depressed due to a large block of brokerage cash moving from a money fund into a bank sweep program. Institutional funds normally see outflows at month-end, and particularly at quarter-end. Tightness in repo and LIBOR rates, and quarter-end window dressing, also likely drew cash from institutional money funds.

Though we expect inflows to return in early July, which usually sees strong asset growth, money funds may also finally be succumbing to investors' aversion to low rates. Among other possible explanations for the recent outflows: expectations of higher rates could be starting a shift away from funds and into direct securities, and consumers may be drawing down their reserves in order to maintain their spending.

"The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent," said the Federal Reserve in a statement released after its two-day meeting ended yesterday. It was the first meeting since August 7, 2007, the week the subprime mortgage liquidity panic began, that the Fed didn't cut interest rates. The Fed began cutting from a Fed funds rate of 5.25% in September 2007, reducing the short-term benchmark by 2.25% over the next 9 months. All indications are the next move is higher.

The Fed's relatively hawkish statement says, "The Committee expects inflation to moderate later this year and next year. However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high."

The Fed warns, "The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time. Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability."

Fed funds futures are showing a 64% chance of a 1/4 point hike by September. The Fed's next meetings are on August 5 and Sept. 15. (See the meeting calendar here.) The Chicago Board of Trade 30-Day Federal Funds Futures also show an 81% chance of a 2.5% rate by November.

The Securities and Exchange Commission, which regulates money market mutual funds, is conducting an open meeting (which started at 10:00 a.m.) this morning where the "Commission proposed rule amendments "that would be intended to reduce undue reliance in the Commission's rules on NRSRO ratings." The Commission "will consider whether to propose rule and form amendments with respect to references in various Commission rules and forms to ratings by Nationally Recognized Statistical Rating Organizations (NRSROs)." To watch or listen, CLICK HERE.

SEC Director of the Division of Investment Management Buddy Donohue said the Commission will discuss the proposed changes thoroughly "because of the complexity and significance of 2a-7". He said that the new rules would offer "similar protections" and that the proposal to "require determination of minimal credit risks" utilize "credit quality assessments prepared by outside sources". He also introduced a requirement that money funds have "sufficient liquidity to meet redemptions" and will expressly define "illiquid securities,", which are already limited to 10% of a portfolio as those able to be "sold or disposed of within 7 days" at or near par. Revisions will also be made to downgrade and default provisions of 2a-7.

As we wrote yesterday (see below), the SEC issued a similar concept release in 2003. It said "Rule 2a-7 under the Investment Company Act of 1940 ... limits money market funds to investing in 'high quality' securities. The rule contains minimum quality standards based on an objective test -- ratings issued by NRSROs -- and on a subjective test -- the credit analysis performed by the adviser to the money market fund. The Commission could eliminate the objective test from Rule 2a-7, and rely solely on the subjective test."

While the proposal to remove the NRSRO language from 2a-7 isn't a huge change, given that money funds were already mandated to do their own credit work and given that funds were already allowed to purchase unrated securities that they deemed of comparable quality, it is likely to face criticism. In 2003, the proposal was met with opposition from the investment management community. (See `comment letters here.)

Investment Company Institute counsel Amy Lancellotta said in a 2003 comment letter that ICI "would strongly object to the elimination of the objective test from Rule 2a-7." ICI said, "While possession of a certain rating by an NRSRO does not provide a 'safe harbor' for purposes of Rule 2a-7, the objective test plays a vital role in providing a regulatory benchmark for funds to meet in order to comply with Rule 2a-7. The objective test, for example, prevents money market funds from taking greater risks to increase yield and from 'stretching' the minimal credit risk definition to any number of investment opportunities that could be inappropriate for maintaining a stable net asset value. By increasing the safety of the securities held by money market funds, the objective test serves to enhance the confidence that investors have in money market funds. For these reasons, we recommend that the Commission continue to rely on the NRSRO designation for purposes of Rule 2a-7."

Another letter, written by former Fidelity Director of Taxable Money Market Research Steve Nelson, stated, "Fidelity opposes the removal of the NRSRO designation from Rule 2a-7. We believe that given current market conditions, allowing the industry to solely rely upon a subjective 'minimal credit risk' test for purchases within money market funds would not provide sufficient protection to investors. Such a change could lead to significant risk inequality across money market funds and undermine investor expectations as to the relative safety of their investments."

While many want to blame the ratings agencies and want regulators to do something, the NRSRO's performance in the money market space has actually been relatively decent. Only a handful of money fund eligible securities have actually defaulted, and the fact remains that no investor has lost a penny over the past year's liquidity crisis. Nonetheless, money funds look forward to a robust debate and discussion, and we look forward to hearing the Commission's proposals.

Today's Wall Street Journal writes "SEC Aims to Rein In The Role of Ratings", which states that the SEC will propose rules eliminating the need for ratings on money market securities. Currently, Rule 2a-7 of the Investment Company Act of 1940, the quality, maturity and diversity regulations governing money market funds, require at least two NRSROs (nationally recognized statistical ratings organizations) to rate securities in their top two categories in order to be money fund eligible.

The WSJ says, "The most significant portion of the rules, to be proposed Wednesday, would make it possible for U.S. money-market funds to invest in short-term debt without regard to ratings put on those securities by firms such as Moody's Investors Service and Standard & Poor's, people familiar with the matter said. Currently, SEC rules generally require that money-market funds purchase only short-term debt with high investment-grade ratings. The new rule would put more discretion in the hands of money managers to determine whether the debt is investment grade."

While it remains to be seen what kind of response the proposal gets, it's clear that some changes, particularly those involving ratings agencies, are in store. The SEC said on June 16 in its Proposed Rules for Nationally Recognized Statistical Rating Organizations, "And third, two weeks from today, the Commission intends to propose rule amendments that would be intended to reduce undue reliance in the Commission's rules on NRSRO ratings."

The SEC's 2003 Concept Release: Ratings Agencies and the Use of Credit Ratings under the Federal Securities Laws" included among proposed alternatives (which were never adopted), "Rule 2a-7 under the Investment Company Act of 1940 ... limits money market funds to investing in 'high quality' securities. The rule contains minimum quality standards based on an objective test - ratings issued by NRSROs - and on a subjective test - the credit analysis performed by the adviser to the money market fund. The Commission could eliminate the objective test from Rule 2a-7, and rely solely on the subjective test."

The SEC will be holding an open meeting on Wednesday to discuss.

Moody's joined S&P and Fitch in downgrading leading municipal bond insurers MBIA and Ambac from its former AAA rating late last week. While tax-exempt money market funds have been bracing for and dealing with bond insurers losing top ratings for months now, the action still should cause some turmoil and consternation among fund managers. As with previous market events, however, most of the risk will be pushed away from money funds and towards other guarantors, this time brokerage firms lending their liquidity to tender-option bonds and variable rate demand notes.

Though we think it's minimal, we'll be researching the potential threat to funds via exposure to MBIA and Ambac more thoroughly in coming days. While money funds continue reducing their exposure, initial indications show that reliance on muni bond insurers has decreased dramatically in 2008. One of the few firms to disclose their monoline insurer exposure, Federated Investors, shows an average holding of 8.2% backed by MBIA Insurance Corp. and an average of 4.2% backed by AMBAC Assurance Corp as of April 30, 2008 across all their tax-exempt money funds. Federated also shows growing allocations to new AAA raters, such as Berkshire Hathaway Assurance Corp.. Last year, before concerns surfaced about municipal bond insurers surfaced, over half of all municipal debt was backed by insurance.

Here we list the 10 Largest Tax Exempt Money Funds (as of 5/31/08), which represent $148 billion of the $500 billion total (444 funds) tracked by our Money Fund Intelligence. These include (with NASD ticker symbol and assets in millions): Vanguard Tax Exempt MMF (VMSXX) <f:vmsxx) $23,557; `Fidelity Municipal MM Fund (FTEXX) $22,550; Merrill Lynch Instit Tax Exempt (MLEXX) $18,851; JPMorgan Tax Free MM Instit (JTFXX) $16,669; Fidelity Instit MM: Tax Exempt I (FTCXX) $11,990; Morgan Stanley Active As Tax-Free (AATXX) $11,712; Goldman Sachs FSq T-F MMF In (FTXXX) $11,271; Merrill Lynch CMA Tax Exempt (CMAXX) $10,801; Western Asset Municipal MM (TFMXX) $10,350; and Federated Tax-Free Obligs IS (TBIXX) $10,242.

We also list the Top-Yielding Tax Exempt Money Funds. These include (with 7-day yield as of May 31): `Alpine Municipal MMF Y (AMUXX) 2.19%; Dreyfus Basic NJ Muni MMF (DBJXX) 2.05%; Lehman Brothers Nat Muni MF Re (LBMXX) 2.02%; USAA Tax Exempt MMF (USEXX) 2.02%; Reserve Interstate Tax-Ex Inst (RIFXX) 2.01%; Reserve Interstate Tax-Ex Liq I (RIEXX) 1.99%; Federated Municipal Obligs IS (MOFXX) 1.97%; Marshall Tax-Free MMF I (MFIXX) 1.97%; `Columbia Municipal Res Z (CRZXX) 1.92%; and Columbia Municipal Res Capital (CAFXX) 1.92%.

Additional coverage includes: Bloomberg's "Insured Short-Term Muni Bonds Surge as High as 9%" and MarketWatch's "Bond insurer downgrades reignite write-down fears".

Money market mutual fund assets fell by $38.91 billion to $3.476 trillion in the week ended June 18, says the ICI's latest report. Tightness in the Fed funds effective and repo rates drew institutional cash from money funds, driven in part by the June 16 quarterly corporate tax payment date. Institutional assets declined by $38.18 billion to $2.255 trillion, while retail assets declined by $730 million to $1.221 trillion. ICI's weekly series tracks 1,172 institutional funds and 838 retail funds for a total of 2,010 money funds.

General purpose ("prime") institutional funds declined by $23.2 billion in the latest week to $1.361 trillion. Over 13 weeks, they've increased by $73.3 billion, or 5.7%. Government institutional funds declined by $15.9 billion to $692.1 billion, while tax exempt institutional funds rose by $891 million to $201.9 billion. Over 13 weeks, Govt Inst funds have declined by $46.7 billion, or 6.3%, as the flight to Treasuries unwound. ICI covers 530 prime institutional funds, 384 government institutional funds, and 258 tax exempt institutional funds.

General purpose retail funds declined by $81 million to $717.7 billion. Over 13 weeks, they've declined by $39.1 billion, or 5.2%. Government retail funds rose by $361 million to $199.4 billion, while tax exempt retail funds declined by $1.01 billion to $304.1 billion. ICI tracks 344 general purpose retail funds, 196 government retail funds (including Treasury funds), and 298 tax exempt retail funds.

Assets should rebound in the coming week. Crane Data's Money Fund Intelligence Daily shows assets rising $13.3 billion on Wednesday, as repo rates and expectations of an imminent Fed funds tightening decline. Year-to-date, total money fund assets have increased by $331.2 billion, or 10.5%, and over 52 weeks assets have increased by $942 billion, or 37.2%.

The largest default event to hit money market mutual funds during the Great Liquidity Panic of 2007 is coming to a close, as receivers have agreed to a restructuring plan for Cheyne Finance, now SIV Portfolio Plc. Cheyne was responsible for the most bailout and support actions disclosed by money funds to date, so its pending resolution is a welcome development to fund advisors who are holding the senior debt and to any unrated funds bold enough to hold the unprotected paper. The at least half a dozen advisors impacted will soon be able to cash out, likely with losses, or roll the debt into a new higher quality debt vehicle.

Bloomberg writes "Goldman Agrees on $7 Billion Cheyne SIV Restructuring", saying, "Goldman Sachs Group Inc. and Deloitte & Touche LLP will sell some assets of a $7 billion structured investment vehicle set up by hedge fund Cheyne Capital Management (UK) LLP, in a model that may be used to wind down similar credit funds. The auction will determine the price at which the remaining assets held by SIV Portfolio Plc, previously known as Cheyne Finance Plc, will be transferred to a company set up by Goldman, said Neville Kahn, a partner at Deloitte in London. The auction will take place during the first three weeks of July, according to Kahn, whose firm is acting as the receiver for the SIV.

Reuters says in its article, "Goldman completes $7 billion SIV restructure," "Other SIVs, including Golden Key, Whistlejacket and Rhinebridge, are expected to follow Cheyne's model, being restructured by Goldman, said Stephen Peppiatt, at Bingham McCutchen, a legal advisor to a Cheyne senior creditor."

Finally, WSJ's "SIV's rescue may aid Goldman, but junior holders may get hurt", says, "For Goldman, it's a real coup. The bank gets the kudos for cutting the SIV knot, and probably a front-row seat on any further restructuring. And for one day, while the switchover takes place, Goldman will effectively be renting out its balance sheet -- undoubtedly for a tidy fee. So when the SIV saga really is history, not everyone will be remembered as a loser."

Our June issue of Money Fund Intelligence XLS Fund Family rankings show the market share trends which started last August continuing in May -- asset floods into larger funds, into instutional funds, and into funds with reputations for quality and/or deep pockets. The largest U.S. money fund manager, Fidelity Investments with $401.8 billion, remains the largest asset gainer over 12 months with an increased of $112.9 billion. But its 39.1% gain even trailed slightly the overall market's increase of 42.4%.

No. 2 BlackRock, with $267.9 billion, showed a huge 71.0%, or $111.2 billion jump, while No. 3 JPMorgan ($251.1 billion) and No. 4 Federated ($237.8 billion) showed big increases of $85.8 billion (51.9%) and $79.4 billion (50.1%), respectively. Retail-heavy complexes, like No. 5 Schwab ($190.2 billion), which increased $44.7 billion (30.8%) and No. 6 Vanguard ($189.4 billion), which increased a "mere" $29.8 billion (18.6%), showed healthy gains but paled when comparison to the institutional increases.

No. 7 Dreyfus ($186.2 billion) and No. 8 Goldman Sachs ($177.5 billion) were among the biggest winners, with percentage increases of 107.3% ($96.3 billion) and 98.2% ($87.9 billion), respectively. No. 9 Columbia ($148.5 billion) and No. 10 Western ($111.2 billion) trailed the marketplace with gains of $21.5 billion (16.9%) and $27.3 billion (32.5%). Like many others, they continue to assuage customer concerns after taking steps to support and protect their money funds from troubled SIV holdings.

Among other notable movers, No. 13 Reserve ($85.2 billion), with an increase of $49.1 billion (136.3%), and No. 21 HSBC ($28.3 billion), with an increase of $17.1 billion (151.8%), continue racking up huge percentage gains. Among the few decliners: Oppenheimer ($23.4 billion) dropped $7.6 billion due to a $10 billion shift of Wachovia Securities' (A.G. Edwards) cash to banks from the Centennial Money Market Trust, and No. 40 Credit Suisse continues its slow painful decline, down $2.3 billion to $7.0 billion.

Money market mutual fund yields, as measured by our bellwether Crane 100 Money Fund Index, rose by a mere one basis point yesterday, from 2.25% to 2.26%. But it appears that a bottom is being reached in money fund yields. Yields should inch higher reflecting expectations of hikes in the benchmark Federal funds target rate in coming months.

Yields declined slightly in May, with the Crane 100 7-Day Yield decreasing to 2.34%. Our broader Crane Money Fund Average fell from 2.08% to 2.03% last month, the Crane Institutional Money Fund Index fell from 2.37% to 2.31%, and the Crane Individual MF Index fell from 1.91% to 1.87%. The Crane Tax Exempt MF Index plunged from 2.05% to 1.33%.

For the month ended May 31, 2008, the Crane 100 returned 0.20% for 1-month, 0.65% for 3 months, 1.29% year-to-date, 4.22% over 1-year, 4.35% over 3 years (annualized), 3.09% over 5 years, and 3.55% over 10 years. The Crane MF Average returned 0.17%, 0.56%, 1.13%, 3.89%, 4.13%, 2.89%, and 3.36%, respectively, for these periods.

This past week, the Crane 100 Index, at 2.25%, has been at its lowest level since its introduction in April 2006. Calendar returns have been calculated for prior years, and 2004's 1.07%, 2003's 0.88%, and 2002's 1.57% all indicate that money fund yields have been much lower during this period. (Fed funds was at a record low of 1.00% from June 2003 through June 2004 vs. 2.00% today.)

See the current issue of Crane Index for the full listing of indexes, and subscribers may contact us for a file with our historical index series.

Lehman Brothers Holdings Inc. and subsidiary Neuberger Berman are the fifteenth advisor to publicly disclose support actions taken to protect affiliated money market mutual funds and their shareholders. Lehman recently disclosed the purchase of $150 million in Sigma Finance medium-term notes in a "no-action" letter just posted by the SEC. Like others before it, the purchase likely occurred long before the fund's $1.00 was threatened and in order to satisfy ratings agency requirements and/or to calm jittery investors. The action is the first disclosed related to Sigma Finance.

While there may have been more support actions triggered by a cut in debt pricing by a third-party service in April, the Sigma, and overall SIV, threat to money funds continues to recede. (See "Money Funds Out of the Woods? Threat From Final SIV Sigma Fading".) The finance company continues making payments on-time and in-full, and continues to be money fund eligible (A-1+/P-2, or "Second Tier"), so some likely questioned and even ignored the pricing service's sudden April turnabout. The current bailout notwithstanding, it's looking increasingly likely that money funds will not suffer significant losses from this final outstanding SIV issue.

Lehman's original letter, written by Willkie Farr & Gallagher's Rose DiMartino on behalf of Prime Master Series, a series of Institutional Liquidity Trust, to the SEC said, "Approximately 1.7% of the Fund's assets as of April 23, 2008 consisted of two Medium-Term Notes issued by Sigma Finance Inc.... Due to current market conditions in the credit markets, including the ability of certain issuers to obtain refinancing, including the issuer of the Notes, the current market value of each Note, as determined by an independent third party pricing agent, is less than its amortized cost value."

"The Adviser has determined that it would be advisable to sell the Notes. However, because of the absence of liquidity in the market for the Notes, the Adviser believes ... that it would not be in the best interests of the Fund and its shareholders to dispose of the Notes in the market. Nonetheless, subject to obtaining the no-action assurance requested in the letter, Lehman Brothers is prepared to purchase the Notes in their entirety from the Fund for cash at each Note's amortized cost," said the letter.

Note that Lehman was previously incorrectly identified as having taken support actions over its money funds. (See "Lehman Liquidations, Support Not Money Fund, Enhanced Related".) This latest disclosure now makes them officially support action number 15. Finally, in other news, Citibank Online Investments has added the U.S. domestic institutional money market funds from Lehman Brothers Asset Management.

On Friday night, the Securities & Exchange Commission issued a "no-action" letter allowing Eaton Vance Management to proceed with a plan to issue "liquidity protected preferred shares (LPP)," a "new type of preferred stock ... to be issued by closed-end investment companies" that would be eligible for purchase by money market mutual funds, said the SEC in its response letter. The new securities would "supplement or replace" auction-rate preferred shares (ARP), because "it is highly unlikely that the existing auction markets for ARP will resume normal functioning in the near term."

The SEC says they are not endorsing money funds investing in the new ARPs, that they do not believe this in any way compromises the integrity of Rule 2a-7, and that they would not have formed a different conclusion had there been no failures in the ARP market. Money funds will still "have to comply with all other provisions of rule 2a-7" and fund advisers will still have to "determine that investment in the ARPs presents minimal credit risks."

An SEC staffer adds, "Because the liquidity features would be unconditional puts, the funds could make this determination based on the issuer of the put." He adds that the Commission worked closely with the Department of Treasury, and that, "The result is a win-win for both the tax exempt money market funds (which need additional source of high quality tax exempt paper) and investors in ARP (who needed liquidity)."

Though the letter clears the way for some auction-rate debt to be repackaged into money fund eligible securities, it remains to be seen whether funds will buy. Some have expressed interest (see our Link of the Day "Federated Comments on ARPS"), but we're still skeptical (see our "Money Funds Keeping Distance From Auction Rate Securities Fiasco").

The letter says, "The LPP will pay a dividend that will be reset every seven days in a remarketing process administered by one or more financial institutions," and that "each Fund will enter into an agreement with a Liquidity Provider ... to purchase unconditionally all LPP". Though it's clear the investments will be permitted by 2a-7, we doubt that money funds will brave the headline risk associated with ARPS.

The Economist this week writes on "Money-market funds: A boom amid the bust." The article discusses money market mutual funds' development and popularity among institutions, as well as funds' role in, and windfall from, the current credit crunch.

The article says, "Long an unexciting province within asset management, money funds have played a big role in the crunch. They bought much of the short-term debt that propped up structured finance. It was their sudden withdrawal that caused the market in asset-backed commercial paper (ABCP) to seize up. And banks' liquidity problems are largely the result of money funds' recent reluctance to hold their debt."

"If this makes them villains, then crime pays. Money funds have been taking market share from banks for years: big banks were less interested in competing for deposits during the securitisation boom, since they were selling on their loans. The crisis only accelerated this shift, since money funds were seen as one of few havens. In America, the biggest market, their assets have increased by 39% over the past year, to a record $3.5 trillion, even as returns have fallen," says the weekly.

The Economist also sources a Crane Data & ICI chart of annual asset growth and returns, and adds, "Money funds have also benefited from a withering of the competition. Ultra-short bond funds and enhanced-cash funds, which touted themselves as cash alternatives but invested in spicier debt than true money funds are allowed to, have fallen by the wayside. Peter Crane of Money Fund Intelligence, a newsletter, puts their combined assets at $70 billion, down from over $600 billion before the crisis. Meanwhile, the market for auction-rate securities is a shadow of what it was."

Finally, the Economist says, "Will money funds be able to hold on to the huge inflows? Mr Crane expects America's to continue registering double-digit annual asset growth. On the other hand, the funds tend to suffer when short-term interest rates rise, or when turmoil subsides. In a recent report, Jan Loeys, an economist at JPMorgan, predicted a bleak future for the funds in which the banks that have become so dependent on them fight back. As the lend-and-hold model of banking regains ground, he argues, so banks' interest in cutting out those interposed between them and their retail customers will grow. Already they are jostling for deposits with new-found vigour."

A number of bond and fixed-income funds were downgraded by Standard & Poor's yesterday, continuing the cascade of bad news for the imploding ultra-short and LIBOR-plus fund sector. S&P says "continued market volatility" and "the latest monoline insurer downgrades" are responsible for the series of 21 fund downgrades. (No money funds were involved.)

S&P says, "The fund volatility rating changes reflect our view of the sustained volatility the funds have experienced, which has led to a monthly return distribution profile that is outside the volatility rating bands for their respective rating categories." In other words, many of the funds are showing negative returns, some shockingly large.

The S&P downgrades were as follows: BlackRock Florida Insured Municipal 2008 Term Trust Inc. (AAAf/S1 from AAAf/S3); BlackRock Insured Municipal 2008 Term Trust Inc. (AAAf/S1 from AAAf/S3); BlackRock Insured Municipal Term Trust Inc. (AAf/S2 from AAAf/S3); BlackRock Insured Municipal Term Trust Inc. (NR from AAf/S2); BlackRock New York Insured Municipal 2008 Term Trust Inc. (AAAf/S1 from AAAf/S3); Corporate Credit (Europe) (Af/S3 from Af/S2); Federated Intermediate Government Fund (AAAf/S2 from AAAf/S1); iShares S&P California Municipal Bond Fund (AA-f/S3 from AAf /S3); iShares S&P New York Municipal Bond Fund (AA-f/S3 from AA+f/S3); Pioneer Investments Euro Geldmarkt Plus (AAAf/S1 from AAAf/S1+); SPDR Lehman California Municipal Bond ETF (AAf/S3 from AA+f/S3); SPDR Lehman Municipal Bond ETF (AAf/S3 from AA+f/S3); SPDR Lehman New York Municipal Bond ETF (AAf/S3 from AA+f/S3); SPDR Lehman Short Term Municipal Bond ETF (AAf/S2 from AA+f/S2); and, Van Kampen Insured Tax Free Income Fund (A-f from Af).

Also, yesterday's Wall Street Journal carried more bad news for the ultra-short sector, saying, "Fidelity Investments is being sued over losses in the Fidelity Ultra-Short bond fund, which invested in risky mortgage-backed securities. A purported class-action lawsuit filed in U.S. District Court in Boston alleges that the Boston mutual-fund giant was 'misleading' in promoting the fund as a safe alternative to cash and that the company didn't adequately disclose risks."

Standard & Poor's Ratings Services assigned its 'AAAm' "principal stability fund" rating to Phoenix Insight Government Money Market Fund (formerly known as Harris Insight Government MMF and to AIM ATST Premier Tax-Exempt Portfolio. S&P announced, "The rating -- the highest assigned to money market funds -- is based on our analysis of the funds' credit quality, market price exposure, and management."

S&P's release says, "Phoenix Investment Counsel Inc. is the investment adviser to the fund and has appointed and oversees the activities of the investment subadvisor, Harris Investment Management Inc. (Harris). Harris is also the subadvisor on the Phoenix Insight Money Market Fund, which has maintained a 'AAAm' rating since January 2003. Based in Chicago, Ill., ... Harris Financial Corp. is wholly owned by Bank of Montreal.... Phoenix Equity Planning Corp. is the administrator, distributor, and transfer agent. Boston Financial Data Services Inc. is subtransfer agent, and PFPC Trust Co. is the custodian."

"The Premier Tax-Exempt Portfolio's investment objective is to provide a high level of current income consistent with the preservation of capital and the maintenance of liquidity. The fund consists of two share classes: Investor and Institutional. In pursuing its investment objective, the Portfolio invests only in high-quality, U.S. dollar-denominated, short-term obligations, including municipal securities, bankers tax-exempt commercial paper, and cash equivalents. Normally, at least 80% of its assets are invested in debt securities that pay interest that is excluded from gross income for federal income tax purposes, and do not produce income that will be considered an item of preference for purposes of the alternative minimum tax," says the S&P announcement.

It continues, "Invesco Aim Advisors Inc. is the fund's investment advisor and manages the fund's investment operation. Invesco Aim has acted as an investment advisor since its organization in 1976. Currently, Invesco Aim advises or manages more than 225 investment portfolios. Assets under management as of March 31, 2008, are more than $490 billion with more than $92 billion handled by Cash Management. Invesco Aim is a direct, wholly owned subsidiary of Invesco Aim Management, an indirect, wholly owned subsidiary of Invesco. Invesco Trimark Services Inc. is the transfer agent for the fund and The Bank of New York serves as the portfolio's custodian."

Finally, S&P says, "In addition to the above funds, we currently rate the following Invesco Aim funds 'AAAm': Short-Term Investments Trust STIC - Prime Portfolio; Short-Term Investments Trust Treasury Portfolio; Short-Term Investments Trust Liquid Assets Portfolio; Short-Term Investments Trust Government & Agency Portfolio; Short-Term Investments Trust Government TaxAdvantage Portfolio; ATST Premier Portfolio; ATST Premier U.S. Government Money Portfolio; and Short-Term Investments Trust Tax-Free Cash Reserve Portfolio."

Money Fund Intelligence recently interviewed the Chief Executive Officer of Invesco Worldwide Fixed Income and Executive V.P. of Invesco Aim Distributors Karen Dunn Kelley. Kelley, who joined what was then known as AIM Investments in 1989 as money market portfolio manager, now oversees Invesco's $160 billion, 120-person fixed income and cash management business.

We asked Kelley, "What have been the biggest contributors to the success of money funds and to Invesco Aim over the years?" Kelley tells us, "Everybody you talk to about money funds will focus on the three philosophical tenets -- safety, liquidity, and yield. The interpretation of those three little words is the key to the success of the money market business.... It was said years ago, Liquidity is like water, you don't know how important it is until you don't have it."

She continues, "Our belief is that the customer is entitled to and wants their dollar to move in and out on a daily basis. So liquidity has to be an overall philosophy, and of course safety is a critical underlying element of liquidity. Right away we understood that safety, liquidity, and yield were not just portfolio management issues, they were a business model. In other words, a portfolio manager is not only required to know the market, but in the money fund business much more is required to execute your fiduciary responsibility."

"One of the things that the founders of AIM -- Ted Bauer, Bob Graham, and Gary Crum -- believed was that a separation of credit and portfolio management was critical in risk management. That is a very unique model in terms of the business. In many areas in portfolio management, the credit people, the traders, the investor are all put together in one reporting structure, or are in many cases one person themselves. We have always felt that in the money fund business you have to have staff dedicated to specific money market research. There has to be a balance between those people having the independent discrete credit decision making responsibilities and those who are making the independent discrete investment decisions," she tells us.

Finally, MFI asks, "Has Invesco Aim managed to escape the SIV turmoil unscathed?" Kelley says, "We have not been in the headlines. We have just not been impacted by it. We don't buy an instrument unless its long-term tested in the market and market cycles. That means we usually don't participate in a new type of security until it gets into the marketplace for a significant amount of time and is well understood. The limited participation we've had in SIVs were not an issue to our portfolios in terms of the few names we bought, the credits we bought and where we bought them on the curve. So we have absolutely had no issues in terms of the SIVs."

See the latest MFI or ask Pete for a copy of the full interview.

The June issue of our flagship Money Fund Intelligence, which was published this morning, features an article that examines institutional money fund asset growth during periods of rising rates, falling rates and flat rates. Crane Data found that since 1990 institutional money fund assets have averaged growth of 1.4% a month, and that during months including an increase in the Fed funds target rate the growth slowed to almost zero (0.1%).

Fed cuts are of course good for assets since funds lag the direct money market. As rates fall, money funds fall slower than repo and commercial paper, so institutional and securities lending money comes pouring into funds. However, as rates rise, much of this "hot" money seeks the temporarily higher yields of direct money market instruments.

Nonetheless, Crane Data does not expect outflows from money funds in a coming rising rate scenario due to a number of factors. Among these are the fact that many of the competitors for money fund cash are now gone or critically wounded. While the torrid 40% asset growth of the past year can't possibly continue forever, we still expect money fund assets to see strong inflows even during a rising rate scenario.

The June issue of MFI also contains an interview with money fund veteran Karen Dunn Kelley of Invesco AIM, an article entitled "Better Money Market Benchmarks: Money Fund Indexes," and of course our regular extensive news, performance listings and rankings tables. Contact Pete for a sample issue.

Downgrades of banks and broker-dealers Monday by Standard & Poor's have raised the possibility that some of these could eventually be in danger of becoming "Second Tier" issuers, which would limit the amount of debt that money market mutual funds could buy. J.P. Morgan Securities published a research piece yesterday, written by Alex Roever and Cie-Jai Brown, entitled, "S&P ratings actions challenge funding for Lehman and Merrill", which discussed this issue.

The note talks about the downgrades of long-term debt ratings on Goldman Sachs, Lehman Brothers, Merrill Lynch, Morgan Stanley, Citigroup, and JPMorgan, but notes that all of these remain comfortably "First Tier" for now. However, Lehman and Merrill's long-term debt ratings were reduced to 'A'. The JPM report says, "S&P has effectively lowered the ratings for these issuers to the precipice of A-2, a rating level that is still considered investment grade, but can only be held in limited amounts by many short-term investors."

Rule 2a-7 of the Investment Company Act of 1940, the quality, diversity and maturity regulations governing money market mutual funds, says that funds may only invest in "First Tier" or "Second Tier" securities. First Tier means at least two of the top short-term ratings, such as A-1, P-1, F-1, while Second Tier means ratings at or above A-2, P-2, F-2, etc. Funds may invest up to 5% of assets in First Tier names, but just 1% per issuer in Second Tier (with a 5% total Second Tier bucket).

Roever says, "A further downgrade by S&P would create an issue for money market investors governed by rule 2a-7.... The rub here is that rule 2-a7 imposes explicit restrictions on the amount of Second Tier securities a fund can hold." But he adds, even with a downgrade, Lehman and Merrill, "would continue to qualify as First Tier securities... since at least two NRSROs continue to rate these firms in the agencies highest short-term rating categories."

"Many prime funds take some or all of their broker exposure in the form of repurchase agreements (repo) which do not necessarily count for purposes of calculating issuer concentrations. Rule 2a-7's portfolio diversification standards permit a fund to 'look-through' a repo to the underlying collateral," says the research note.

Finally, the report says, "With recent events having dramatically elevated the level of risk aversion among money funds and other short term investors, it would seem that the willingness of investors to weather market challenges is more limited than normal." But JPM doesn't believe the events are a "near-term threat to overall solvency", citing the Fed's Term Securities Lending Facility (TSLF) and Primary Dealer Lending Facility (PDLF), as well as other funding sources.

Money fund assets grew by $18.06 billion to $3.520 trillion this week and are just $16.4 billion below their all-time record of $3.536 trillion set the week ended April 9. Institutional assets rose by $13.91 billion to a record $$2.292 trillion. Retail assets, meanwhile, rose $4.15 billion, to $1.227 trillion; they remain $42 billion below their pre-income tax payment record level.

Year-to-date, money funds assets have increased by a robust $375.5 billion, or 11.9%, and their gains over 52 weeks remain eye-popping, up $992 billion, or 39.2%. Institutional money funds, which represent 65% of the overall total, have increased assets by $310 billion, or 15.6%. Retail money funds have lagged YTD with asset growth of a "mere" $65 billion, or 5.6%.

Money market mutual funds continue to experience strong growth following two of their best years in history for asset gains. In 2007, money fund assets rose by over $752 billion (32.0%), by far their largest increase ever, and in 2006, money funds jumped almost $314 billion, their 3rd best showing ever. (In 2001, money fund assets increased by $440 billion, or 23.8%.)

Money funds continued to benefit from their competitors' woes, as cash from ultra-short bond funds, enhanced cash funds and a host of frozen or underwater formerly higher-yielding short-term "safe" assets flee into sectors that continue to maintain principal and liquidity. Money funds assets also continue to benefit from a long-term trend away from banks and towards funds, and a reversal of the decades long push for pension, stock and other funds to remain fully invested.

At the recent flurry of Treasury Management Conferences, online money market fund trading portals remained a hot topic. Below we discuss some of the new developments and points of interest for those unable to make it to the traditional spring treasury trade show tour (or for those too busy to actually attend any of the sessions).

At Treasury Management of New England's Conference, Goldman Sachs' Managing Director Jesse Cole presented on "Understanding and Evaluating Money Market Portals". Cole discussed the history of and trends in the portal marketplace, and educated attendees on how to evaluate various trading platforms. He said, "Everyone has the wrapper, the window, but behind there are two models -- fully disclosed and omnibus." What is important, Cole tells us, is "understanding what and how things happen behind the screen".

Cole predicted, "It's only a matter of time before there's consolidation" and said the "next stage" in portal development is "integration with treasury, auto-money movements and multi-product". On online commercial paper (CP) trading, he says, "We have historically not seen very much adoption. He says the market preference seems to be for a "multi-dealer solution" like the one Tradeweb already offers.

Goldman's Cole mentioned the difficulties some treasury workstation users have had integrating their trading portals, though he mentioned that Peoplesoft and SAP are looking at the sector. This brought a response from one audience member, Scott Montigelli of Kyriba, who disagreed and suggested that Kyriba would be entering the space in the near future.

Finally, he says to evauluate providers, "Know what you or your organization wants to automate or access, because not all the bells may be needed." He adds, "Understand the provider's commitment to the business. Do they really have the experience and depth?"

Other portal discussions at recent treasury conferences included: Institutional Cash Distributor's (ICD's) John Geary's "The Future of Money Market Portals," who discussed future enhancements at TMANE, including the rollout of Clearwater Analytics "transparency" initiative, and Mellon LMS's Kirk Black's "Transforming Treasury Investing with Portal Technology," which discussed "streamlinging the short-term investment process" at the New York Cash Exchange.

Money market mutual fund yields declined slightly in May, though their 9-month long decline appears to be at an end. Our broadest benchmark Crane Money Fund Average fell slightly from 2.08% to 2.03% (7-day current annualized yields as of month-end), while the heavily "prime" fund weighted Crane 100 Money Fund Index, a measure of the 100 largest money fund, fell harder, from 2.47% to 2.35%. The Crane Tax Exempt Money Fund Index plummeted from 2.05% to 1.36%.

Treasury fund yields rebounded while Government and Prime fund yields declined in May. The Crane Treasury Institutional Money Fund Index rose from 1.61% to 1.78%, and the Crane Treasury Individual MF Index rose from 1.19% to 1.32%. The Crane Government Institutional Index drifted lower, from 2.22% to 2.19%, and the Crane Govt Individual Index moved from 1.85% to 1.80%. The larger Crane Prime Insitutional Money Fund Index fell from 2.75% to 2.59%, and the Crane Prime Individual Index fell from 2.29% to 2.15%. Brokerage and bank rates declined slight in May too.

Assets of money market mutual funds rebounded in May, following tax-related April outflows. ICI's weekly series show money funds gaining approximately $87 billion in May to break back above the $3.5 trillion level. Institutional funds led the advance, adding about $96 billlion, while Retail funds declined by almost $10 billion. Individuals continued seeing some tax outflows in May (it takes weeks for the IRS to clear checks), though some investors undoubtedly returned to bond and equity markets as concerns ease over markets and the economy.

See the pending June issue of Money Fund Intelligence and Crane Index for more details.

While attempts to clean up the mess in the auction-rate securities continue, and are making progress, many of the tentative rescue plans are incredulously relying on repackaging the securities for purchase by money market funds. Money market mutual funds were never allowed to purchase ARS, or ARPS (auction-rate preferred securities), due to the lack of a "hard put", and we think it's very unlikely that they will want to become affiliated with the tainted security class at this point.

Auction-rate securities were clearly supposed to be classified as non-cash equivalent investments according to statements by accountants, media, regulators and accounting standards bodies. Our Money Fund Intelligence August 2006 issue said, "PricewaterhouseCoopers recently took another shot at auction rate securities ... saying these ... 'may also have been inappropriately classified as cash equivalents' by corporations, according to a Wall Street Journal story "Firms Ponder What Constitutes Cash" (7/27/06).... FASB 95 describes cash equivalents as "short-term, highly liquid investments".... Generally, only investments with original maturities of three months or less qualify under that definition."

Why some expect money market funds to now lend their good name to this tainted sector is mystifying. Last week's Asset-Backed Alert newsletter featured a story entitied, "Treasury Engineering Auction-Rate Rescue", which describes a program that "apparently calls for Goldman and Lehman to create an asset-backed commercial paper facility ... that would fund purchases of auction-rate student loan bonds by issues short-term debt secured by those instruments". Normally, this might be a good idea, but getting money funds to purchase anything tainted by headline risk in this environment will be challenging to say the least.

We sympathize for companies grappling with these problems (see Financial Week's "Companies split on taking ARS cash hit"), and we expect investors to recover all of their assets if they can wait it out. But we are baffled by anyone arguing that investors weren't aware of these risks, and are confused by those offering solutions which clearly are unlikely to work.

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