News Archives: September, 2010
Though September's asset totals will likely show a modest decrease, the Investment Company Institute's latest monthly "Trends in Mutual Fund Investing" confirms that money market mutual fund assets posted their first monthly increase since January 2009, when fund assets hit a record $3.9 trillion. ICI's numbers show money fund assets increased by $19.4 billion, or 0.7%, in August 2010 to $2.827 trillion. (Crane Data's Money Fund Intelligence showed assets increasing by $22.9 billion in August, but we show assets falling by $16.6 billion MTD in September.)
The ICI report shows money fund assets down by $488.8 billion, or 14.7%, YTD through August. Bond funds, which are now almost as large as money funds with $2.581 trillion, have increased by $374.6 billion YTD. The "Trends" report says, "Money market funds had an inflow of $19.05 billion in August, compared with an outflow of $6.21 billion in July. Funds offered primarily to institutions had an inflow of $25.57 billion. Funds offered primarily to individuals had an outflow of $6.53 billion."
In a separate report, ICI's members-only "Month-End Portfolio Holdings of Taxable Money Market Funds" shows Repurchase Agreements with the largest increase in August, up $16.6 billion. CDs had the second largest increase, up $17.1 billion. CP declined by $5.8 billion. Over 3 months, Repo holdings have increased by $53.4 billion, and YTD they've increased by $74.1 billion. Every other major asset class of money funds is showing substantial year-to-date declines. (Govts are down $136.0 billion, CP is down $125.9 billion, CDs are down $117.8 billion, and Treasuries are down $95.4 billion.)
Repos, which surpassed CDs in June to become the largest money fund holding, remain in the No. 1 holding spot with $563.7 billion, or 22.6% of money fund assets. Certificates of Deposit allocations remain in second place with $552.9 billion, or 22.2%. (We include CDs and Eurodollar CDs, which total $101.5 billion in money funds, or 4.1%, in this total.) U.S. Government Agency Securities remain the third largest holding in taxable money funds at $417.9 billion, or 16.8%, followed by Commercial Paper with $394.4 billion, or 15.8%. U.S. Treasury Bills and Other Treasury Securities rank fifth with $319.2 billion, or 12.8%. Notes, including Bank Notes and Corporate Notes, account for $159.9 billion, or 6.4% of total holdings, while Other assets total $73.2 billion, or 3.3%.
Average Maturities of taxable money funds rose in August according to ICI to 43 days from 39 days. This compares to 36 days in June but is down dramatically from a 51 day average at the end of January 2010. The Number of Accounts Outstanding rose for the first time since November 2008, increasing by 117,015 to 28.745 million. The Number of Funds tracked by ICI's survey fell to 450 from 456 a month earlier. This total is down from 490 a year earlier and 543 two years ago.
On Friday, the Investment Company Institute released a letter to the Financial Accounting Standards Board entitled, "ICI Comments on FASB Accounting for Financial Instruments Proposal. The letter says, "The Investment Company Institute appreciates the opportunity to comment on the proposed accounting standards update Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities (ASU or Proposal). Among other things, the ASU would: 1) require investment companies to recognize transaction costs on the purchase and sale of portfolio securities as an expense in the statement of operations and expense ratio; 2) require money market funds that comply with Rule 2a-7 under the Investment Company Act of 1940 to measure their investments at fair value (rather than amortized cost) when reporting holdings in their financial statements; and 3) require investment companies to measure financial liabilities at fair value, and recognize changes in fair value of financial liabilities in earnings."
Under the section on "Money Market Funds" on page 8 of the letter, ICI says, "The ASU would require money market funds that comply with rule 2a-7 under the Investment Company Act of 1940 to measure their investments at fair value, rather than amortized cost. The Proposal, at Question 6, asks whether reporting those investments at fair value, rather than amortized cost, would provide financial statement users with decision-useful information. Rule 2a-7 permits SEC-registered money market funds to calculate their net asset value per share for purposes of issuing and redeeming fund shares using amortized cost (in lieu of fair value), provided they meet certain risk-limiting conditions. The risk-limiting conditions are intended to provide assurance that any deviation between the fair value of the portfolio and its amortized cost is minimal, and results in calculation of a share price that represents fairly the current net asset value per share of the fund. The risk-limiting conditions minimize a money market fund's exposure to credit, currency, interest rate, and liquidity risks."
It continues, "Rule 2a-7 also requires money market funds to calculate, on a periodic basis, the current net asset value per share using available market quotations for their portfolio securities. This 'shadow pricing' is intended to illustrate, for the fund's board and management, any deviation between the current net asset value per share based on amortized cost and net asset value per share based on available market quotations. If the deviation results in material dilution or other unfair results to existing shareholders, under the rule, the fund's board must cause the fund to take action to eliminate or reduce such dilution or unfair results."
ICI explains, "The SEC recently adopted Rule 30b1-7, which requires money market funds to report portfolio information on new Form N-MFP to the SEC within five business days after the end of each month. Form N-MFP requires money market funds to disclose, for each portfolio security held by the fund, 1) the total principal amount to the nearest cent, 2) the total current amortized cost to the nearest cent, and 3) the value of the security, calculated using available market quotations (or an appropriate substitute that reflects current market conditions). In addition, Form N-MFP requires money market funds to disclose the most recently calculated net asset value per share using available market quotations (or an appropriate substitute that reflects current market conditions) to the nearest hundredth of a cent. Money market funds must first file Form N-MFP beginning with the filing covering the month ended November 30, 2010. The SEC has indicated that it will make funds' filings on Form N-MFP publicly available 60 days after the month end to which the filing relates. Accordingly, beginning on or about February 1, 2011, current fair values for money market fund holdings, as well as the net asset value per share based on those fair values, will be publicly available through the SEC. Such information will be updated on a monthly basis."
The letter states, "We see no practical benefit associated with requiring money market funds to measure their holdings at fair value (in lieu of amortized cost) when reporting their investments in their financial statements. Accordingly, we urge the Board to clarify that money market funds that comply with rule 2a-7 may continue to measure their investments at amortized cost for financial reporting purposes. First, due to rule 2a-7's risk limiting conditions, under normal circumstances, any deviation between the amortized cost value and the fair value of the fund's holdings will be insignificant. We note that money market funds have, for many years, measured their holdings at amortized cost for financial reporting purposes, and that auditors, notwithstanding GAAP's requirement for investment companies to measure their holdings at fair value, have not objected to this presentation. We believe auditors have concluded appropriately that amortized cost does not differ materially from fair value. Further, we believe the fund's periodic shadow pricing process, in which the fund calculates net asset value per share based on available market quotations, confirms there is no significant deviation."
It adds, "In those rare circumstances where the fair value of a particular holding differs materially from amortized cost (i.e., due to an issuer default), industry practice is to measure the holding at its fair value in the fund's financial statements. In addition, the fund would separately disclose any credit support arrangement from the fund sponsor measured at fair value. Such presentation would be supplemented with note disclosure detailing the terms of any credit support arrangement. Second, as described above, fair value information for each money market fund holding will be publicly available in SEC Form N-MFP beginning on or about February 1, 2011. This information will be updated on a monthly basis. Accordingly, the fair value information that the Board would require under the Proposal will be available through the SEC to investors and others, and it will be updated more frequently (monthly vs. quarterly)."
Finally, the letter concludes, "For the reasons described above we believe there is no practical benefit associated with measuring the money market fund's investments at fair value in the fund's financial statements and urge the Board to clarify that such funds may continue to measure their investments at amortized cost. Recommendation - In lieu of requiring money market funds to measure their investments at fair value, we recommend the Board consider requiring these funds to disclose the fair value of the investment portfolio at the reporting date in the notes to the financial statements. Such disclosure would enable financial statement users to assess any difference between the amortized cost and fair value of the fund's portfolio." (For more comment letters on the FASB site, click here.)
A release entitled, "FDIC Board Proposes Rules on Temporary Unlimited Deposit Insurance Coverage for Noninterest-Bearing Transaction Accounts," says, "The Federal Deposit Insurance Corporation (FDIC) Board of Directors today approved the issuance of a proposed rule to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act to provide depositors at all FDIC-insured institutions unlimited deposit insurance coverage on noninterest-bearing transaction accounts beginning December 31, 2010 through December 31, 2012."
FDIC Chairman Sheila Bair explains, "In October 2008, the FDIC instituted a program providing unlimited protection for noninterest-bearing transaction accounts at participating banks and found it to be highly successful in providing stability at those institutions during one of the most severe economic downturns in our history. The Dodd-Frank provision is different from the FDIC's program but continues the purpose of that program as we emerge from the economic crisis."
The release continues, "Under the proposal, the FDIC will create a new, temporary deposit insurance category for noninterest-bearing transaction accounts. These accounts are primarily checking accounts used by businesses for payrolls, accounts payable and other purposes. Unlike the FDIC's voluntary Transaction Account Guarantee ('TAG') Program, which will expire at the end of this year, the Dodd-Frank provision will apply at all FDIC-insured institutions and it will cover only traditional checking accounts that do not pay interest. The proposed rule emphasizes that, starting January 1, 2011, low-interest consumer checking accounts and Interest on Lawyer Trust Accounts (IOLTAs) (currently protected under the TAG Program) will no longer be eligible for an unlimited guarantee."
It adds, "The proposed rule requires insured depository institutions to provide notice and disclosure requirements to ensure that depositors are aware of and understand the types of accounts that will be covered by this temporary deposit insurance coverage. To comply with the disclosure and notification requirements, institutions must: post a notice in their main office, each branch and, if applicable, on their Website; notify customers currently covered by the FDIC's TAG Program that, beginning January 1, 2011, low-interest checking accounts and IOLTAs no longer will be eligible for unlimited guarantee; and notify customers individually of any action they take that will affect the deposit insurance coverage of funds held in noninterest-bearing transaction accounts."
Finally, it says, "The FDIC will be accepting comments on the proposed rule through October 15, 2010. The shorter than usual comment period is necessary to give insured institutions adequate time to implement the notice and disclosure requirements by December 31, 2010." Click here for the full document.
In other news, another release entitled, "FDIC Board Approves Final Rule Regarding Safe Harbor Protection for Securitizations," says, "The Board of Directors of the Federal Deposit Insurance Corporation (FDIC) today approved a final rule to extend through December 31, 2010, the Safe Harbor Protection for Treatment by the FDIC as Conservator or Receiver of Financial Assets Transferred by an Insured Depository Institution in Connection With a Securitization or Participation. Under this safe harbor, all securitizations or participations in process before the end of 2010 are permanently grandfathered under the existing terms of 12 C.F.R. Part 360.6." See also, "ASF Says FDICs Safe Harbor Action Hurts Liquidity and Seriously Threatens Government's Ability to Exit Housing Market."
We recently became aware of another academic study involving events surrounding the "Subprime Liquidity Crisis." A paper entitled, "When Safe Proved Risky: Commercial Paper during the Financial Crisis of 2007-2009," written by two Assistant Professors of Finance at the Stern School of Business of New York University, Marcin Kacperczyk and Philipp Schnabl, was recently published in the Journal of Economic Perspectives.
The paper says, "Commercial paper is a short-term debt instrument issued by large corporations. For issuers, commercial paper is a way of raising capital cheaply at short-term interest rates. For investors, commercial paper offers returns slightly higher than Treasury bills in exchange for taking on minimal credit risk. At the beginning of 2007, commercial paper was the largest U.S. short-term debt instrument with more than $1.97 trillion outstanding. Most of the commercial paper was issued by the financial sector, which accounted for 92 percent of all commercial paper outstanding."
It continues, "Commercial paper played a central role during the financial crisis of 2007–2009. Before the crisis, market participants regarded commercial paper as a safe asset due to its short maturity and high credit rating. Two events changed this perception. The first event began to unfold on July 31, 2007, when two Bear Stearns' hedge funds that had invested in subprime mortgages fifi led for bankruptcy. In the following week, other investors also announced losses on subprime mortgages. On August 7, 2007, BNP Paribas suspended withdrawals from its three investment funds because of its inability to assess the value of the mortgages and other investment held by the funds."
The work explains, "Given that similar assets served as collateral for a specific category of commercial paper -- asset-backed commercial paper -- many investors became reluctant to purchase asset-backed commercial paper. The total value of asset-backed commercial paper outstanding fell by 37 percent, from $1.18 trillion in August 2007 to $745 billion in August 2008. Other categories in August 2007 to $745 billion in August 2008. Other categories of commercial paper remained stable during this period."
Kacperczyk and Schnabl write, "The second event occurred on September 16, 2008, when the Reserve Primary Fund -- a large money market fund with $65 billion of assets under management -- announced that it had suffered significant losses on its $785 million holdings of Lehman Brothers' commercial paper. Instead of each of its shares being worth $1 -- a common rule in the money market industry -- the Reserve Fund announced its shares were worth only 97 cents. In other words, the fund 'broke the buck' -- an occurrence that had happened only once before in the history of money market funds."
They continue, "This news triggered the modern-day equivalent of a bank run, leading to about $172 billion worth of redemptions from the $3.45-trillion-worth money market fund sector. The run stopped on September 19, 2008 -- three days after it started -- when the U.S. government announced that it would provide deposit insurance to investments in money market funds. Even though the announcement halted the run on money market funds, most funds nonetheless reduced their holdings of all types of commercial paper because they deemed them too risky. Within one month after the Reserve Fund's announcement, the total value of commercial paper outstanding fell by 15 percent, from $1.76 trillion to $1.43 trillion."
The paper adds, "To stop the sudden decline in commercial paper, the Federal Reserve decided -- for the first time in its history -- to purchase commercial paper directly. The Federal Reserve started purchasing commercial paper on October 26, 2008, and its action promptly stabilized the market. By early January 2009, the Federal Reserve was the single largest purchaser of commercial paper and owned paper worth $357 billion, or 22.4 percent of the market, through a variety of lending facilities. Throughout the year 2009, the Federal Reserve steadily reduced its holdings and by October 2009 it held $40 billion of commercial paper, accounting for 3.4 percent of the market."
Finally, they say, "We will offer an analysis of the commercial paper market during the financial crisis. First, we describe the institutional background of the commercial paper market. Second, we analyze the supply and demand sides of the market. Third, we examine the most important developments during the crisis of 2007–2009. Last, we discuss three explanations of the decline in the commercial paper market: substitution to alternative sources of financing by commercial paper issuers, adverse selection, and institutional constraints among money market funds."
The Federal Reserve Bank of New York loosened its requirements for allowing money funds to become repo counterparties with the Fed from $20 billion to $10 billion. The Fed released an updated "RRP Eligibility Criteria for Money Funds II" late yesterday. It says, "This document sets forth the criteria for acceptance as a counterparty eligible to participate in reverse repurchase transactions (RRP) with the Federal Reserve Bank of New York (FRBNY). FRBNY may engage in RRP, if at all, at the direction of the Federal Open Market Committee (FOMC) in order to drain reserves."
The Criteria explains, "In any such RRP, FRBNY will sell securities held in the System Open Market Account (SOMA) to counterparties subject to an agreement to repurchase them at some future date. FRBNY will use the existing industry tri-party infrastructure to undertake any such RRP. In addition, as with current operations, FRBNY intends to use an auction format for awarding transactions to counterparties. Upon submission of an application and acceptance of that application by FRBNY, an applicant will be added to a public list, maintained on FRBNY's website, of RRP counterparties. Inclusion on such list simply means that the entity is eligible to engage in RRP with FRBNY. It does not mean that the entity is eligible for any other program or transactional relationship with FBRNY. It does not in any way constitute a public endorsement of that entity by FRBNY, nor should such be viewed as a replacement for prudent counterparty risk management and due diligence. FRBNY reserves the right to amend its list of RRP counterparties at any time and for any reason in its sole discretion."
Under "Initial Eligibility," the NY Fed says, "To be accepted as a RRP counterparty, an applicant must: A. be an open-end management investment company that is organized under the laws of a State of the United States, registered under the Investment Company Act of 1940, holds itself out as a money market fund, and is in compliance with the requirements of Rule 2a-7 under such Act, B. have net assets of no less than $10 billion for six consecutive months (measured at each month-end) prior to the submission of the application, C. have been in existence for at least one year prior to the submission of the application, D. be a consistent investor in the tri-party repo market (in particular, in transactions collateralized by U.S. government debt, agency debt, and agency MBS securities), E. be able to confirm and arrange settlement of a significant volume of transactions with FRBNY, and F. be able to satisfy the following transaction requirements: (a) execute RRP with securities margined at 100% (i.e. the value of the securities provided by FRBNY will equal the funds provided by the counterparty), (b) execute term RRPs, with tenors of one-week or longer3, (c) submit minimum bids of $1 billion or greater, (d) execute RRP for next day settlement, and (e) execute the requisite RRP documentation including FRBNY's Master Repurchase Agreement, triparty custody documentation and other documentation, as applicable."
It adds, "In addition to the foregoing, before being accepted as a RRP counterparty, an applicant must satisfy an FRBNY review, consistent with prudent counterparty risk management, of its and its investment adviser's, as applicable, financial condition, compliance program and internal control environment. In connection with this review, FRBNY may consult with the U.S. Securities and Exchange Commission (SEC) and/or the relevant Self-Regulatory Organization (SRO) and other regulators, as applicable, regarding the review considerations listed above, as well as any other matter FRBNY deems relevant. An applicant and, as applicable, its investment adviser, must maintain a compliance program consistent with the applicable regulatory requirements. FRBNY will not accept as a RRP counterparty any applicant, that, in FRBNY's judgment, poses undue risks to the integrity, reputation, or assets of FRBNY."
Crane Data's Money Fund Wisdom database shows that 51 funds from 19 managers fit the new $10 billion-plus criteria, up from 26 funds from 14 managers under the $20 billion for six months criteria. (See the Fed's previous "Reverse Repo Counterparties List" and Crane Data's August 19 News "New York Fed Publishes Reverse Repo Counterparty List of MMFs".) Potentially eligible new funds from new fund managers include: American Funds Money Mkt Fund, Morgan Stanley Inst Liq Prime and Northern Instit Govt Select, State Street Inst Liquid Res, and UBS Select Prime Money Mkt. Contact us if you'd like to see our full list of funds with assets over $10 billion for 6 consecutive months.
The Federal Reserve Board released a paper in its "Finance and Economics Discussion Series" entitled, "The Cross Section of Money Market Fund Risks and Financial Crises" written by Patrick McCabe from the Fed Board of Governors's Division of Research & Statistics and Monetary Affairs. The paper's Abstract says, "This paper examines the relationship between money market fund (MMF) risks and outcomes during crises, with a focus on the ABCP crisis in 2007 and the run on money funds in 2008. I analyze three broad types of MMF risks: portfolio risks arising from a fund's assets, investor risk reflecting the likelihood that a fund's shareholders will redeem shares disruptively, and sponsor risk due to uncertainty about MMF sponsors' support for distressed funds."
McCabe's Abstract continues, "I find that during the run on MMFs in September and October 2008, outflows were larger for MMFs that had previously exhibited greater degrees of all three types of risk. In contrast, as the asset-backed commercial paper (ABCP) crisis unfolded in 2007, many MMFs suffered capital losses, but investor flows were relatively unresponsive to risks, probably because investors correctly believed that sponsors would absorb the losses. However, the consequences of MMF risks were quite costly for some sponsors: Using a unique data set of sponsor interventions, I show that sponsor financial support was more likely for MMFs that previously earned higher gross yields (a measure of portfolio risk) and funds with bank-affiliated sponsors. Funds' gross yields and bank affiliation (but not funds' ratings) also would have helped forecast holdings of distressed ABCP. This paper provides some useful lessons for investors and policymakers. The significance of MMF risks in predicting poor outcomes in past crises highlights the importance of monitoring such risks, and I offer some useful proxies for doing so. The paper also argues for greater attention to the systemic risks posed by the industry's reliance on discretionary sponsor support."
The Introduction explains, "Money market funds (MMFs or 'money funds') have an impressive record of price stability. From the introduction of the rules specifically governing these funds in 1983 until the Lehman bankruptcy in September 2008, only one small MMF lost money for investors, and that loss, in 1994, had little broader impact on the industry. Although MMF prospectuses and advertisements must warn that 'it is possible to lose money by investing in the Fund', investors virtually never lost anything. Indeed, the perceived safety of MMFs typically prompted inflows to the funds during periods of heightened uncertainty and motivated some academic researchers to suggest that money funds might function well as 'narrow banks' that provide liquidity services."
It says, "However, two crises in the MMF industry during the financial turmoil that began in 2007 underlined the importance of money fund risks for MMF investors and sponsors, as well as for the broader financial system. The meltdown of the market for asset-backed commercial paper (ABCP) that began in August 2007 caused capital losses for many money funds that held ABCP, but the losses were absorbed by MMF sponsors (that is, asset management firms and their parents and affiliates), so MMF investors lost nothing. In contrast, losses on Lehman Brothers debt following that firm's bankruptcy in September 2008 caused the Reserve Primary Fund to 'break the buck' -- its share price fell below $1 -- and cost its shareholders liquidity as well as principal (as of this writing, the assets of the fund still had not been completely distributed). Moreover, the damage quickly spread beyond Reserve and its investors amid a broader run on MMFs. Other money fund investors were put at risk as concerns about the funds' vulnerabilities prompted a vicious cycle of redemptions, efforts by MMFs to sell assets, declines in prices for money market instruments, and the possibility of capital losses that motivated further redemptions. A broader liquidity crisis developed as MMF managers, facing enormous redemptions, curtailed their lending to firms and institutions. The run on MMFs appears to have been slowed only by announcements on September 19 of unprecedented government interventions to support MMFs and short-term funding markets."
McCabe writes, "The two crises I study provide different perspectives on the importance of MMF risks. The run on MMFs in 2008 was not indiscriminate; I find that redemptions from prime MMFs marketed to institutional investors were correlated significantly with ex ante indicators for each of the three types of risk. For example, outflows were larger for MMFs that had paid higher gross yields in the previous year and thus were likely carrying greater portfolio risks, for funds with larger pre-crisis flow volatility that signified greater investor risk, and for funds that had sponsors with wider credit default swap (CDS) spreads and hence greater sponsor risk. Meanwhile, net redemptions from retail prime MMFs during the run varied with investor risk proxies but not significantly with portfolio or sponsor risk measures, perhaps because retail investors -- who generally did not redeem shares en masse -- were less cognizant of MMF vulnerabilities and posed lower investor risk for the funds. Indeed, one lesson from the distinction between institutional and retail investors' behavior during the run is the interactions among fund risks: MMFs with greater investor risks were also more sensitive to portfolio and sponsor risks."
He adds, "Interactions among fund risks were also consequential during the ABCP crisis, as widespread sponsor support absorbed funds' losses. With sponsor risks apparently dormant, other MMF risks -- at least as perceived by fund shareholders -- also remained latent, and the funds saw only modest net outflows that exhibited little cross-sectional correlation with ex ante risks. However, MMF risks were consequential for money fund sponsors; their financial support for their funds reflected concerns about actual or expected losses in funds' portfolios as well as concerns about investors' potential responses to those risks. Using a unique data set of sponsor support actions in the wake of the ABCP crisis, I show that portfolio risks, as measured by gross yields in the year prior to the crisis, are useful for predicting whether sponsors intervened to support their funds. A separate analysis of MMFs' holdings of distressed ABCP corroborates this result. Interestingly, sponsor risk played a more complex role in ABCP crisis than during the run in 2008. MMFs with bank-affiliated sponsors, which presumably had particularly deep pockets with which to support ailing money funds, were more likely both to hold troubled ABCP and to receive financial support to absorb losses. However, controlling for bank affiliation, riskier sponsors (those with higher pre-crisis CDS spreads) were more likely to experience problems."
Finally, McCabe adds, "My findings provide some useful lessons for MMF shareholders and policymakers alike. The significance of MMF risks in predicting poor outcomes in past crises underscores the importance of monitoring these risks, and this paper offers some useful proxies for doing so. For example, shareholders and regulators might track funds' gross yields for early signs of undue portfolio risks, particularly in light of asset managers' incentives to take on risks to boost yields. This paper also shows that MMF risks are broader than the portfolio risks that are the focus of the current regulatory framework for money funds. The importance of investor risk during the run in 2008 lends some support for the Securities and Exchange Commission's (SEC's) 2009 proposals to require additional liquidity for funds that are marketed to riskier investors, such as institutional investors, and the proxies for investor risk that I employ may be useful for identifying funds with riskier clienteles. The link between sponsor risk and holdings of distressed paper during the ABCP crisis indicates that the sponsor-support option may distort incentives for portfolio managers, and the role of sponsor risk in channeling concerns about financial institutions to their off-balance-sheet MMFs during the 2008 run suggests that expectations for such support may contribute to transmission of financial shocks. These concerns at least warrant greater attention to the systemic risks posed by the MMF industry's reliance on sponsor support."
The Federal Reserve released its latest quarterly "Flow of Funds Accounts of the United States - Z.1" last week. The Flow of Funds contains several tables related to money market funds, including L. 206 "Money Market Mutual Fund Shares," which shows investor types in money funds, and L.121 "Money Market Mutual Funds," which shows investments held by money funds. The Z.1 report shows that households, funding corporations and nonfinancial corporate businesses remain the dominant categories of money fund shareholders, and that households and funding corporations (which include securities lenders) continued to drive the outflows from funds in Q2 of 2010.
The household sector remains by far the largest holder of money fund shares with $1.11 trillion, or 37.9% of the $2.931 trillion tracked by the Fed in Q2. Households reduced their money fund holdings by $78 billion in the second quarter, or 2.7%, and they've reduced holdings by $354 billion, or 24.2% over the 1-year through June 30, 2010. Overall money fund assets declined by $654 billion, or 18.2%, over the same 12 months.
Funding corporations, defined by the Fed as "funding subsidiaries, nonbank financial holding companies, [and] custodial accounts for reinvested collateral of securities lending operations," remain the second largest holder of money fund shares with $745 billion, or 25.4% of assets. This is down by $48 billion, or 1.6%, in the latest quarter and $266 billion, or 26.3%, in the latest year. Funding corporations have shrunk their money fund balances from a high of $1.071 trillion at year-end 2008, a decline of $326 billion, or 30.4%. (Households have shrunk balances by $463 billion, or 29.4% during this same period.)
Nonfinancial corporate businesses rank third among money fund investors, according to the Fed's quarterly Z.1 series, with $528 billion, or 18.0% of assets. Corporates reduced their holdings at a slower pace in the quarter, dropping $35 billion or 1.3%, but their money fund holdings fell a sharp $164 billion, or 23.7% over the year.
The Fed's money fund holdings table shows "Time and savings deposits" and "Open market paper" with the biggest declines in Q2. These lost $73 billion and $63 billion, respectively. Security RPs (repos) were the only segment to increase (up $23 billion); these represent the largest holding of money funds with $463 billion, or 15.8% of assets. Agency and GSE backed securities rank second with $450 billion (15.4%), while Time and savings deposits rank third with $432 billion (14.7%). Open market paper (CP) ranks fifth with $386 billion (13.2%), while Treasury securities and Municipal securities tie for sixth place with $351 billion (12.0%) each.
For more on the Fed's Flow of Funds, visit www.federalreserve.gov/releases/z1/Current/ or e-mail info@cranedata.us to request Crane Data's Excel files of the Fed's money fund tables.
Last week, we quoted from Federated Investors' CEO Chris Donahue, who spoke recently at Barclays Capital's "2010 Global Financial Services Conference". (See Crane Data's Sept. 14 News "Federated's Donahue Says Liquidity Bank Idea Whose Time Has Come".) Today, we quote Donahue's responses from the Q&A section of his presentation, when he was asked about capital reserve requirements and the ultra-low rate environment. His responses follow.
He was asked, "How can you be so sure that capital requirement won't be part of the opening solution for the money market fund industry? Donahue answered, "Well, I can't be sure about it, but I'm confident about it. Here is why. Let's say they even go with ... requirements of 7% [capital]. JPMorgan has over $400 billion dollars of assets. Where are they going to get their $30 billion dollars of capital, if that is the number? [Even if] that is too high, because money funds shouldn't be as much, would it be half of that, or $15 billion? Even that doesn't work in the business. Capital requirements like that are the same as sounding the death knell of the money fund as a business. At some point, the economics have to work as well, and at some point those capital numbers are too high in order to allow the business to function."
He continued, "JPMorgan is the example I like to use because they are not in favor of capital either, and we find it something that is in our mind unnecessary if you go along with the liquidity bank.... [W]e have access to $500 million dollars ... we are not exactly short hitters on this field either. We are able to play ball at those kinds of levels. But if they decide that it should be 7.5%, then really they are telling something different about the existence of the money fund business. And we just don't think that is what's going to happen."
Donahue explained, "Furthermore, I think there is an overlay for various people that they are always going to be discussing these kind of subjects, whether is capital or variable NAV, because no one wants to just say, 'Oh, well everything is perfect....' So in order to protect themselves ... various regulators will always be studying these types of issues. We've tried to reflect our views in terms of what we've done. There is no reason for us to have to buy SunTrust's assets if we didn't believe the kinds of things that I was just saying. I can't be certain about what the regulators will do, but we have a lot of confidence that that won't be in the offing."
He was also asked how the business would fare if rates stayed this low for 5 years. Donahue answered, "If short rates stay at these levels for 5 years, you have bigger problems than what is going to happen in money funds. We just don't foresee that, however. We are determined as an enterprise because of how we structure our business that we can withstand these low interest rates even if they go through '10, '11, etc.... [T]he reason is that we are basing this on the core expenses of the fund being covered.... As long as interest rates, meaning the short term repo rate ... stays at or about 20 bps -- that means that over time the gross yield on those funds would be 20bps -- all of the third party cost and core expenses are covered. There is even some amount of bps to be divided among intermediaries, Federated and the customers in actual yield. We are in it for the long haul, but I've never heard anybody with the projection that interest rates are going to stay [down for] 5 years, or that [the Fed] means by the word 'extended' some sort of 5-year run."
In yet another move that could hurt the triple-A money fund ratings business, Standard & Poor's appears poised to change its Fund Ratings Criteria to require ratings on all repo counterparties. An S&P "Fund Ratings" RFP sent out Friday says, "This Request For Comment proposes criteria regarding the evaluation of counterparty credit risk for funds with principal stability fund ratings (PSFRs) and fund credit quality ratings (FCQRs), including the use of repurchase agreements (repos). The proposed criteria revisions apply to all global rated funds with PSFRs and FCQRs."
The RFC's Summary comments, "Standard & Poor's Ratings Services is proposing to modify criteria for assessing counterparty credit risk in funds with PSFRs and FCQRs. These counterparty transactions include repos, reverse repurchase agreements, swaps, forward purchases, foreign-exchange contracts, and other hedging positions. Specifically, when evaluating funds with PSFRs and FCQRs we propose that counterparties (e.g., broker/dealers) that do not have an explicit issuer or counterparty credit rating from Standard & Poor's or do not have a guaranty of their obligations from a Standard & Poor's-rated entity will be viewed as having high credit risk. We are not seeking to make any additional criteria changes for the use of repos at this time, nor are we considering reviewing collateral in lieu of having highly rated counterparties."
S&P is seeking input on the following questions: "Do you believe that unrated counterparties pose potentially significant credit risk to highly rated funds that have a PSFR or FCQR? Does your opinion change if the unrated counterparty is 50% or more owned by a rated parent?"
They explain, "Based on the existing counterparty exposures of funds with a PSFR or FCQR, we believe most funds will likely modify their eligible counterparty list for rated funds or withdraw their fund ratings. However, for other funds, we believe the implementation of these criteria will result in substantial rating changes because many funds currently have significant exposure to unrated counterparties."
S&P says of its "Methodology," "Funds commonly hold significant exposure to counterparties through the use of repos, swaps, and other transactions. Key to these exposures is the counterparties' credit risk. Existing criteria for funds with PSFRs and FCQRs state that unrated entities that are at least 50% directly owned by rated parents are considered to have the same level of credit risk as the parent when considering counterparty credit risk for these transactions.... We are now proposing an update to our ratings criteria for assessing the counterparty credit risk of unrated subsidiaries of rated banks and finance companies that transact repos and other obligations with funds that have a PSFR or FCQR."
It adds, "In light of the significant turbulence and dislocation in the banking sector during the past few years, we are now reevaluating the ongoing parental support of these subsidiaries in assessing the subsidiaries' creditworthiness. We believe it is important to understand a subsidiary's stand-alone credit profile, the strategic significance of the subsidiary to the group, and the parent's ultimate willingness to provide extraordinary support if needed. Given this uncertainty, we are proposing that repos and other obligations from unrated counterparties be viewed as high-risk assets."
Finally, they say, "We likely will assess the credit risk of obligations from an unrated counterparty as inconsistent with investment-grade PSFRs.... In addition, although our fund ratings criteria consider counterparty ratings and collateral types for purposes of diversification in repos, we generally do not take into account for rating purposes collateral sufficiency, timing of repo contract termination payments, enforceability of repurchase contract terms and conditions, or jurisdictional considerations with regard to initial and variation margin postings." S&P proposes an implementation period of 150 days after the final criteria are published and "encourage[s] all interested market participants to submit comments in writing on the proposed criteria by end of business Oct. 18, 2010."
The Investment Company Institute published "The Economics of Providing 401(k) Plans, Services, Fees and Expenses, 2009," an annual report that "examines the economics of providing 401(k) plans" Though money fund assets account for just $105 billion, or 7%, of the $1.5 trillion in 401(k) plan mutual fund assets, according to the study, the ICI report does have some interesting statistics on money fund expense ratios.
It says, "[E]xpense ratios of stock and bond funds averaged slightly higher in 2009, compared with 2008. The asset-weighted average expense ratios paid by 401(k) investors on their stock funds rose 3 basis points to 0.74 percent. The asset-weighted average expense ratio paid by 401(k) investors on their bond funds increased 2 basis points to 0.55 percent. Meanwhile, for money market funds, the asset-weighted average expense ratios paid by 401(k) investors fell 2 basis points to 0.36 percent."
ICI's 401(k) plan study comments on Money market funds," "Seven percent of 401(k) mutual fund assets were invested in money market funds at year-end 2009. For 401(k) participants holding money market funds, their total expense ratio was 0.36 percent of assets in 2009, compared with an industrywide simple average of 0.49 percent. In recent years, the 401(k) money market fund asset-weighted total expense ratio averages have been very close to the industrywide asset-weighted averages."
It adds, Furthermore, the asset weighted average expenses paid by 401(k) investors on their money market funds was 2 basis points lower in 2009 compared with 2008. The decline in money market fund fees in 2009 was due in part to individual funds reducing their fees in some cases as investment advisers waived advisory fees in the low interest rate environment."
In other news, ICI reported in its weekly "Money Market Mutual Fund Assets" that, "Total money market mutual fund assets decreased by $24.55 billion to $2.814 trillion for the week ended Wednesday, September 15, the Investment Company Institute reported today. Taxable government funds decreased by $1.11 billion, taxable non-government funds decreased by $20.17 billion, and tax-exempt funds decreased by $3.26 billion." (Funds normally see outflows on the 15th of each month due to tax payments.)
Two years ago today, the money market mutual fund industry, and the world economy, were irrevocably changed as Reserve Primary Fund "broke the buck" following the bankruptcy of Lehman Brothers. This event triggered a near panic in the money markets and an unprecedented level of government intervention and support. As we did last year, below we excerpt a number of quotes from Crane Data's September 2008 News Archives, including the week which will live in infamy, September 15 through Sept. 19.
Sept. 15, 2008, as the unexpected Lehman bankruptcy news hit, we expected to see yet another cluster of routine support actions from money fund advisors. Crane Data wrote (incorrectly, it turns out) early Monday, in "Fed Moves, Limited Exposure Should Shield Money Mkts From Lehman," "The bankruptcy filing of Lehman Brothers has led to a downgrade of the company's short-term debt by Moody's from P-1 to Not Prime. The impact to money market fund is likely to be contained, however, since Lehman had been a minor issuer in the commercial paper (CP) and medium-term note (MTN) marketplace, with about $3 billion in CP outstanding. There also likely will be repercussions from the company's repurchase agreement and other short-term financings and supports. These issues, though, should be alleviated by the other news of the weekend -- the Fed's move to expand its liquidity facilities, and the takeover of Merrill Lynch by Bank of America."
Later that day (Monday, 9/15/08), we wrote, "Evergreen Issues Statement Supporting Lehman Holdings in Funds," "A number of money market mutual funds are in the process of issuing statements either saying that they have no exposure to Lehman Brothers, which was downgraded to 'Not Prime' from P-1 ('First Tier') earlier today, or saying that they are taking steps to support their funds (or that their holdings are not large enough to impact the $1.00 NAV). Evergreen Investments was the first to issue a statement today saying that they've taken action to support their money funds. Though Lehman CP and MTN holdings are not widespread in money funds, other announcements are expected to follow."
On Tuesday, September 16, 2008, Crane wrote, "Lehman Support Actions Push Money Fund Bailouts to 20 Total, which said, "We wrote yesterday about money funds' limited exposure to Lehman Brothers and about the support actions taken by investment advisors so far. Evergreen and Russell have disclosed support agreement for their funds, while some other funds have disclosed Lehman holdings and pledged to maintain their $1.00 NAVs. The vast majority of money funds appear to have no direct exposure to Lehman, though they're now answering questions on AIG, which was downgraded to A-2 but is still P-1 (short-term ratings), and WaMu."
It continued, "The latest crisis should bring Crane Data's tally of the number of advisors supporting their money funds over the past 13 months to 20. Besides Evergreen, money funds disclosing or showing holdings of Lehman in recent public filings include: Columbia Cash Reserves, which held $400 million, or 0.73% of its assets; Reserve Primary; and Russell Money Market Fund. All are expected to protect their funds from any threat to the $1.00 a share NAV should it become necessary.... [A] Dow Jones story also says, [S]everal money funds reported holdings in Lehman paper in their most recent filings.... One example is the Primary Fund managed by New York money manager The Reserve. As of May 31, the $64.85 billion Primary Fund had some $785 million in Lehman commercial paper and medium-term notes.' It added, 'The Reserve has historically protected the NAV of its money funds as needed.'"
But it soon became clear that Reserve would not be able or not choose to bail out its fund. Describing events the afternoon of Sept. 16, 2008, Crane Data wrote, "In just the second case of a money market mutual fund 'breaking the buck,' or dropping below the $1.00 a share level, in history, The Reserve's Primary Fund cuts its NAV to $0.97 cents on Tuesday. The top-ranked fund, which held $785 million in Lehman Brothers CP and MTNs, was besieged by redemptions over the past two days. Assets of the total portfolio, which is largely institutional but which includes some retail assets, declined a massive $27.3 billion Monday and Tuesday to $35.3 billion." (Note that we were unaware at the time that many of these redemptions were halted.) (See the full 2008 story, Reserve Primary Fund "Breaks the Buck" Following Run on Assets and see our October 2008 Money Fund Intelligence for more details.)
Reserve said in its statement, "The Board of Trustees of The Reserve Fund, after reviewing the unprecedented market events of the past several days and their impact on The Primary Fund ... approved the following actions with respect to The Primary Fund only: The value of the debt securities issued by Lehman Brothers Holdings, Inc. (face value $785 million) and held by the Primary Fund has been valued at zero effective as of 4:00PM New York time today. As a result, the NAV of the Primary Fund ... is $0.97 per share. All redemption requests received prior to 3:00PM today will be redeemed at a net asset value of $1.00 per share." (Note that Reserve Primary Fund shareholders have since received $0.99 cents per share to date.)
Finally, Crane Data wrote on Sept. 16, 2008, "Though money fund investors will undoubtedly be shocked and nervous over yesterday's events, we believe Reserve will be an anomaly. The combination of high yields, hot money and a lack of deep pockets likely will prove fatal to the oldest money market mutual fund. As happened in 1994 with the liquidation of Community Bankers U.S. Government Money Market Fund at $0.96 a share, we expect money market funds to soldier on with just a single case of a fund 'breaking the buck'."
This month's Money Fund Intelligence revisits OppenheimerFunds, which we previously profiled in our October 2007 issue (following their entry into the institutional money fund marketplace). Below, we interview members of the company's Cash Strategies team and managers of Oppenheimer Money Market Fund and Oppenheimer Institutional MMF. Excerpts from our Q&A with Senior Vice President, Director & Portfolio Manager Carol Wolf, VP & PM Chris Proctor, and VP Jesse Levitt follow.
First we asked, "How has Oppenheimer been weathering the storm and now the yield drought? Proctor responds, "We have enjoyed strong relative performance during the credit crisis and in this current low interest rate environment. We think the reason for this is because we continue to stick to our investment process that has been in place since Carol took over the group. The investment process is a formal delineation of responsibilities that we have between portfolio management, trading and credit. This is set up so that there isn't excessive risk taking from any one group in the pursuit of performance."
He continues, "We admit that operating in this rate environment remains very difficult. We've seen outflows, like others, in our retail funds. Our institutional base has remained steady over this time." On the tumultuous environment, Proctor adds, "It does give you opportunities. But we don't change our investment process because of a blip up in LIBOR.... The general investment strategy we employ is one where we take advantage of our approved credit list, the names that we like, while we try to maintain flexibility for when rates increase, as they did recently."
We then asked, "How long have you all been running money funds? Wolf answers, "We've been running funds for over 30 years. It began back with the Daily Cash Accumulation Fund and the Centennial Funds in the '70's. I have been in the money market business since the mid-'80's.... Chris has been with Oppenheimer for 2 years, but he has 20 years of money market experience. I have a team of 11 people, and they average 12 years of money market experience."
Proctor says, "We have $12.2 billion in cash assets that fall under our Cash Strategies umbrella. There are four different types of assets. We run 2a-7 funds, about $8 billion there and we run some separate account money, both 2a-7-like and also non-2a-7 out to 3 years. Probably the fastest-growing segment that Carol manages is the collateral for the funds which is managed with Agencies and Treasuries. That's the cash collateral for derivatives contracts in the commodities funds. Oppenheimer's overall mutual fund assets are currently about $163 billion."
MFI asks, "What's your biggest challenge? Wolf says, "I think the biggest challenge today is the 30% liquidity bucket imposed by the amendments to Rule 2a-7. Supply is falling and everybody is looking [to put] 30% of their portfolio in that short period. This keeps yields very, very low in the 7 day and under space.... We've seen consolidation in the banking and in the asset-backed commercial paper sector, so a lot of issuers that we previously invested in are no longer issuing. In the past [the challenge] was credit, and it still remains credit. Knowing what it is that you are really buying.... Knowing what the asset-backed paper structures are is something that has always been one of our strengths."
Levitt adds, "On the distribution side, the historically low yield environment has made it increasingly difficult to draw new money fund investors. Alternative investment options have become more attractive, and as multiple money fund yields continue to cluster together, there becomes a greater emphasis on differentiating yourself by other means." Look for more excerpts from our interview in coming days, or e-mail info@cranedata.us to request the full article.
Federated Investors' CEO Chris Donahue spoke yesterday morning at Barclays Capital's 2010 Global Financial Services Conference and discussed fee waivers, the liquidity exchange bank, and industry consolidation among other things money market. Donahue says Federated, which recently celebrated 55 years in the fund business, started with a simple concent. "[P]eople want to invest their money in pools with professional management and diversification," he comments.
Donahue says, "No story on Federated would be complete without some focus on our money market funds.... Our compound annual growth rate [in assets since 1999] has been about 9%.... We look at this business as a high single digit growth business.... We've seen a leveling off to slight increase in our asset flows. This is important in terms of evaluating waivers." The accompanying slides show Federated's assets at $231 billion as of 6/30/10, with $99 billion in bank trust, $43 billion in capital markets, $68 billion in broker dealer, and $21 billion in the corp/other channel.
He continues, "In the first quarter, our waivers of ordinary income were about $17.8 million dollars. In the second quarter they dropped to $13, and we said on our [earnings] call and are sticking with it, that for Q3 we are comfortable with the idea of $11 to 12 million dollars. That's reflective of a combination of a lot of different factors with a lot of changing variables. The one variable that doesn't appear to want to change too quickly is the Fed's attitude about what rates should be. Our people along with most of the rest of the pundits believe that changes in that are not in the offing for the rest of this year, more or less, for sure."
Donahue comments, "We're pretty happy with our position in the money fund business. So happy in fact ... that we're willing to add to this franchise and if do nothing else stimulate the consolidation that's going on here.... [A]s regards regulation, remember the watchwords of all of this various moves have been to quote 'enhance the resiliency of money funds,' whether it was the President's Working Group, whether it was Congress, whether it was the regulators, [or] whether it was Mary Schapiro.... Since 1980, $325 trillion dollars have successfully moved through money funds ... and they have paid $450 billion more in income than had that money been in a comparable MMDA account. Money funds are an integral part of the financial system as well, helping to assist, in a short term, financing Treasuries, Agencies, Munis, Commercial Paper, Repos and the like."
He adds, "In terms of other issues, for example, capital, this is always an issue that has been brought up in studied by various pundits. Our belief is that they are not going to assign capital to money market funds. We have always believed that the money market fund business is an investment product business and [you] should be judged on your competence and your experience in this business and that has proven to be the case.... What's really necessary to further enhance the resilience of money funds is the adoption of the liquidity bank."
Donahue explains, "This is an idea that grew out of a request form the Presidents Working Group.... [S]o the ICI Working Group came up with the liquidity bank idea. The idea is very simple. You create a state trust company or a bank that is then funded by two different things -- contributions by investment advisors who own commercial paper money funds and by the commercial paper money funds themselves. This capital builds up and is used for the purpose of taking care of liquidity problems. Notice I didn't say credit. This is a liquidity bank solution. At the end of the day the liquidity bank has access to Fed, and this was what really solved the problems in the money fund industry in the late September '08 time frame. So we think it is an excellent idea whose time has come."
Note also that BlackRock's Larry Fink will speak Tuesday morning at 9:45am EDT at the same conference. See the release entitled, "BlackRock CEO to Speak at Barclays Capital 2010 Global Financial Services Conference on September 14th," for details.
Neuberger Berman appears to be the latest casualty of ultra-low rates, asset outflows and rising regulatory requirements in the money market mutual fund space. A recent SEC filing for the Neuberger Berman Income Funds and Neuberger Berman Municipal Money Fund says, "The Board of Trustees of Neuberger Berman Income Funds recently approved the liquidation of Neuberger Berman Municipal Money Fund, which is scheduled to occur on or about September 28, 2010. Investors may continue to redeem shares of the Fund through the Liquidation Date."
The "Supplement to the Summary Prospectus dated February 28, 2010, as amended June 7, 2010, and the Prospectus dated February 28, 2010, as amended April 1, 2010 and May 28, 2010 continues, "Effective August 24, 2010, the Fund's shares will no longer be offered for sale to new investors. Existing shareholders of the Fund can continue to purchase shares. If you purchased shares directly through Neuberger Berman Management LLC or through an account with Neuberger Berman LLC, you should have received a letter describing alternative arrangements for the investment of your assets once the Fund is liquidated. If you purchased shares directly through Neuberger Berman Management LLC, please call 800-877-9700 with any questions. If you purchased shares through an account with Neuberger Berman LLC or another investment provider, please contact your Neuberger Berman representative or your investment provider, as appropriate, with any questions."
Neuberger Berman, the former Lehman Brothers Asset Management, ranks 61st among 81 money fund managers (tracked by Crane Data's Money Fund Intelligence XLS) with $763 million in assets (0.03% market share). The company outsourced its taxable money market funds to SSgA in July 2009. (See Crane Data's July 10, 2009, News "Neuberger Retreats From Taxable Money Funds, Outsources to SSgA" and Neuberger's July 9, 2009, press release "Neuberger Berman Selects State Street To Provide Taxable Money Market Funds To Its Clients".) The liquidations involve all three of Neuberger's remaining tax-exempt money funds, the $200 million Neuberger Berman Muni MF Invest (NMNXX), the $248 million Neuberger Berman NY Muni MF (NYNXX), and the $315 million Neuberger Berman Tax-Fr MF Res (NTFXX).
The company becomes the latest in a still small but growing line of companies to abandon or outsource its money market fund lineup. (Note that Neuberger does continue to manage "cash" though and continues to subadvise for SEI's Tax-Exempt Money Market Funds.) Other announcements of liquidation and deals this year include: AARP Money Market Fund, Eagle's Money Market Funds, Goldman Sachs' ILA money funds, RidgeWorth Money Market Funds, and Western Assets's retail brokerage money funds. (For more, see Money Fund Intelligence's August article, "Consolidation Happens: MF Mergers, Liquidations.")
In other news, see FT.com's reprint of the recent ignites.com article, "Moody's moves to improve ratings differentiation". It says, "Moody's last week proposed changes to its methodology for rating money market funds aimed at providing investors with greater transparency regarding fund characteristics and a better picture of both market and liquidity risks." (See Crane Data's Sept. 8 News "Moody's Proposes New Money Market Fund Rating Methodology, Symbols".)
The following piece excerpts from the September issue of Money Fund Intelligence.... One of the sessions at our recent Crane's Money Fund Symposium was entitled "Money Fund Investors & Due Diligence." Part of this presentation was given by The Mosaic Company's Senior Cash Management Analyst Michael Crawford, who discussed one company's thinking and processes behind choosing money funds and cash investments.
Crawford told MFS, "As all of us are aware, the corporate investing landscape has changed dramatically in the last two years. This is especially true when we look at the short term liquidity market. Traditionally, money market funds were key instruments in managing short term cash availability. This changed when The Reserve Fund broke the 'buck'.... The ensuing liquidity crisis money funds experienced (as investors sought to convert these holdings) forced other fund closures. Could anything have been done to prevent this?"
He continued, "Due diligence is key for all of us. Ultimately, institutional investors must determine what they will invest in for the benefit and cash management of their corporations. This means truly understanding what comprises the assets that are actually under management and monitoring the changes in those assets."
Crawford explained, "Partnering with money market portals can supply critical daily information to aid in monitoring. Using the information provided in an efficient, downloadable form is one key to ongoing due diligence.... The most obvious and most critical tool is having transparency to the portfolio underlying the AUM. Since the market and portfolio managers are constantly reacting to the market, this is impossible in a real time environment. However, there are ways to trend past money funds holdings."
Crawford told the Symposium audience, "Concentration monitoring of holdings is another due diligence weapon in trending across multiple money market funds. This trending can add an extra level of knowledge in determining your partner money market funds. Complementing [this] with appropriate industry intelligence [should] round out the due diligence process. I'm not talking about James Bond or the CIA, but identifying key news and industry sources for regular review and information. It is my opinion that all of these points listed are paramount to an effective due diligence process as an institutional investor."
Finally, Crawford said, "These points provide the basis for solid due diligence and a key part of an overall process. As an investor, I want to express with confidence to my senior management that we have a comprehensive process in place to review and quantify our investments." E-mail us at info@cranedata.us to request a copy of the full article.
In addition to Tuesday's controversial move by Moody's Investors Service to abandon its triple-A ratings scale for money market mutual funds (see yesterday's Crane Data News, ratings agencies are also featured in a new ICI Credit Rating Agencies Reform Resource Center. And NRSROs are mentioned in the fund profile in the latest Money Fund Intelligence.
ICI's new Resource Center explains, "A credit rating agency assigns credit ratings for issuers of debt, as well as the debt instruments themselves (including bonds, preferred stock, and commercial paper). Mutual funds employ credit ratings in a variety of ways—to help make investment decisions, to define investment strategies, to communicate with their shareholders about credit risk, and to inform the process for valuing securities. The need for reliable and credible ratings has grown along with the complexity of the capital markets. Meanwhile, the financial crisis of 2008–2009 made clear the serious flaws in the ratings process and the urgency of reforms such as better disclosure, increased accountability, and improved rating presentations. In October 2009, and again in December 2009, the Securities and Exchange Commission (SEC) proposed amendments that would impose a series of new requirements on registered rating agencies to improve disclosure about credit ratings and the ratings process and address conflicts of interest between rated issuers and the rating agencies."
It continues, "With the Dodd-Frank Wall Street Reform and Consumer Protection Act, Congress decided to codify many of the measures that were a part of the SEC proposals as well as require additional oversight requirements that were not a part of the SEC proposals. This resource center provides information about reform efforts for the improvement in the way credit rating agencies function. This page will be updated as events unfold." (The web address is: http://www.ici.org/cra.) The Center contains a host of hotlinks to prior discussions of issues involving NRSROs.
Separately, Crane Data wrote in its August 23 News "SEC Issues No-Action Letter, Allows Putting NRSRO Designations on Hold", "At the end of last week, the U.S. Securities & Exchange Commission issued a "no-action" letter ... which allows fund board to delay implementation of the designation of NRSROs (nationally-recognized statistical ratings organization) until further notice." In the letter, the SEC's Associate Director of the Division of Investment Management `Robert Plaze wrote Investment Company Institute General Counsel Karrie McMillan, "As you know, the amendments to rule 2a-7 under the Investment Company Act of 1940 that the Commission adopted last February require[d] boards of directors of money market funds to designate at least four nationally recognized statistical rating organizations ('NRSROs') whose ratings the fund would use to determine the eligibility of portfolio securities under the rule."
But the September issue of Money Fund Intelligence shows that some are going ahead with the designations. MFI quotes OppenheimerFunds Carol Wolf, "We are going to ask our boards to designate four NRSROs. By doing this, we can focus on the NRSROs that we believe provide some good information on our credits. We don't rely on NRSROs for their analysis; we use them for an initial screen. We do our own internal credit analysis, but with 11 NRSROs to monitor it will be nice to be able to just cut it down to the ones that we believe provide the best value."
Yesterday, Moody's Investors Service published a paper entitled, "Moody's Proposes New Money Market Fund Rating Methodology and Symbols." Its Introduction says, "This Request for Comment describes the framework of a proposed new methodology for rating money market funds (MMFs).... [W]e are proposing the introduction of a new set of rating symbols and definitions we believe will better address the unique risks of money market funds and better distinguish our money market fund ratings from our credit ratings on long-term debt obligations."
A Moody's press release says, "Moody's Investors Service is requesting market participants to comment on a proposed new methodology and rating scale for money market funds. The refined rating methodology, if implemented after a 60-day request-for-comment period, would recalibrate Moody's primary analytical inputs, such as a fund portfolio's underlying asset quality, its liquidity position and susceptibility to market risk, and the likelihood of support from its sponsor." It adds, "Under the proposed rating system, Moody's would also introduce a new five-point rating scale for money market funds ranging from MF1+ (strongest) to MF4 (weakest)."
Yaron Ernst, Managing Director of Moody's Global Managed Investments group, comments, "Our current rating scale uses the traditional Moody's long-term ratings, but has different rating definitions for managed funds. Our new scale, which further differentiates the factors we consider when rating money market funds, will give investors a much better view of how a fund may perform even during times of severe market pressure.... In addition to clarifying the difference between money market fund ratings and Moody's traditional debt ratings, the new methodology will provide investors with more differentiation among money market funds, and more transparency regarding the key factors that affect a fund's ability to meet its objectives."
The release adds, "The new rating scale is being proposed to better capture the risks of money market funds in which investors hold shares, but also expect immediate payment on demand. Accordingly, we plan to rate money market funds based on our opinion on their ability to meet the dual objectives of preserving principal and providing liquidity. The new rating scale would (a) factor in the generally low risk of the underlying money market fund assets,(b) consider a fund's liquidity profile and the potential for a 'run' on the fund, (c) assess a fund's sensitivity to interest rate shifts, and (d) assess the likelihood of sponsor support."
The Request for Comment asks, "Why Are We Proposing Methodology Changes? It answers, "There are a number of reasons why we are proposing a change to our rating methodology and the introduction of a new rating scale for money market funds.... In September 2008, 31 rated funds suspended redemptions, leading to delayed distributions, and in two cases, shareholders in those funds experienced principal losses.... This experience prompted a reconsideration of the approach we use to assign MMF ratings. Moody's initiated a dialog with fund managers, investors, and other market participants to come to a better understanding of the type of information investors in money market funds seek, the role of ratings in their investment decisions, and the particular attributes of our ratings that they find most valuable."
It continues, "Historically, we have rated money market funds using an approach that emphasizes portfolio credit quality and maturity structure, with consideration also given to factors such as portfolio strategy, manager/adviser characteristics, and the likelihood of sponsor support. The performance of money market funds during the financial crisis, particularly after the Lehman Brothers' bankruptcy, heightened investors' focus on the wide range of risks facing these funds.... The proposed methodology is intended to more effectively capture these risks by introducing objective measures to better assess factors such as liquidity risk and market risk, as well as asset quality and obligor concentrations. Greater emphasis is placed on a sponsor’s willingness and ability to support a given fund or group of funds, if need be, as has happened throughout the history of this sector. Extending our analysis of money funds in areas that are increasingly important to investors is expected to result in greater ratings differentiation than under the existing methodology."
The paper adds, "Finally, under Section 938 of the recently passed Dodd-Frank Wall Street and Consumer Protection Act -- the US financial reform bill -- upon rule-making by the Securities and Exchange Commission, nationally recognized statistical rating organizations will be prohibited from having multiple definitions for the same rating symbol. Since the form and nature of money market funds is distinct from bonds rated using our traditional Aaa to C long-term rating scale, and our rating approaches and rating definitions are different, we are proposing a new rating scale that better highlights the distinction between these two types of ratings."
The September issue of Crane Data's flagship Money Fund Intelligence newsletter ships to subscribers this morning. Our latest monthly contains articles on "Assets' Summer Bottom; Will Yields Re-Test Lows?," a discussion of the new trough in assets and falling yields; "OppenheimerFunds: Conservatively Competitive," our monthly profile which interviews Carol Wolf, Chris Proctor, and Jesse Levitt; and "The Mosaic Co.'s Crawford Speaks on Due Diligence," which excerpts from one corporate cash analyst's money fund monitoring strategies. The new MFI also contains performance data as of August 31, 2010 (on a shrinking universe of 1,254 money market funds), our benchmark Crane Money Fund Indexes, and a recap of the month's money fund news.
The lead piece in Money Fund Intelligence says, "The good news is that money fund assets appear to have formed a trough during the summer of 2010. After hitting a record of $3.92 trillion in January 2009, assets declined by almost $1.1 trillion, or 27.9%, over the next 15 months. Since May, however, assets have in effect been flat and appear to have stabilizing at their current $2.8 trillion level. The bad news is that yields, which had rebounded from a record low of 0.04% in February 2010 to 0.11% in mid-August, have begun inching downward again."
Our OppenheimerFunds profile quotes VP & Portfolio Manager Proctor, "We have enjoyed strong relative performance during the credit crisis and in this current low interest rate environment. We think the reason for this is because we continue to stick to our investment process that has been in place since Carol took over the group. The investment process is a formal delineation of responsibilities that we have between portfolio management, trading and credit. This is set up so that there isn't excessive risk taking from any one group in the pursuit of performance.... We admit that operating in this rate environment remains very difficult. We've seen outflows, like others, in our retail funds. Our institutional base has remained steady over this time."
Finally, our September issue says, "One of the sessions at our recent Crane's Money Fund Symposium was ... given by The Mosaic Company's Senior Cash Management Analyst Michael Crawford, who discussed one company's thinking and processes behind choosing money funds and cash investments. Mosaic, which is based in Plymouth, Minnesota, is 'the world's leading producer and marketer of concentrated phosphate and potash.' We excerpt from Crawford's comments."
Crawford told MFS, "As all of us are aware, the corporate investing landscape has changed dramatically in the last two years.... Partnering with money market portals can supply critical daily information to aid in monitoring.... Complementing [this] with appropriate industry intelligence [should] round out the due diligence process."
Let us know if you'd like to see the full issue of Money Fund Intelligence or if you'd like to see our latest Money Fund Intelligence XLS or Crane Index. (E-mail Assistant Editor Kaio Barbosa (kaio@cranedata.us) to request a sample.)
Federal Reserve Chairman Ben Bernanke spoke yesterday on "Causes of the Recent Financial and Economic Crisis" before the Financial Crisis Inquiry Commission. Bernanke discussed short-term funding problems, shadow banking and commented briefly on money market mutual funds' role in the crisis. He said, "Chairman Angelides, Vice Chairman Thomas, and other members of the Commission, your charge to examine the causes of the recent financial and economic crisis is indeed important. Only by understanding the factors that led to and amplified the crisis can we hope to guard against a repetition."
Bernanke explained, "In midsummer 2007, events unfolded that would engender a sea change in money market conditions, triggered by fears of subprime losses that had been growing during the first half of the year. To choose one of several possible key dates, on July 30, 2007, IKB, a medium-sized German bank, announced that in order to meet its obligations, it would be receiving extraordinary support from its government-owned parent and an association of German banks. IKB's problem was that its Rhineland off-balance-sheet vehicle was no longer able to roll over the asset-backed commercial paper (ABCP) it had been issuing in U.S. markets to fund its large portfolio of asset-backed securities. Although none of the securities in the Rhineland portfolio was in default and only some were subprime-related, commercial paper investors had become concerned about IKB's ability to meet its obligations in the event that the securities Rhineland held were downgraded."
He continued, "Around the same time, other vehicles similar to that of Rhineland were also finding funding rollovers to be more costly and difficult to arrange. These difficulties intensified over subsequent weeks, as investors around the world pulled back funding; indeed, outstanding U.S. ABCP plummeted almost $200 billion in August. The economist Gary Gorton has likened this pullback to a traditional bank run: Lenders in the commercial paper market and other short-term money markets, like depositors in a bank, place the highest value on safety and liquidity. Should the safety of their investments come into question, it is easier and safer to withdraw funds -- 'run on the bank' -- than to invest time and resources to evaluate in detail whether their investment is, in fact, safe.... Ultimately, the disruptions to a range of financial markets and institutions proved far more damaging than the subprime losses themselves."
Talking on "Dependence on Unstable Short-Term Funding," be commented, "Shadow banks are financial entities other than regulated depository institutions (commercial banks, thrifts, and credit unions) that serve as intermediaries to channel savings into investment. Securitization vehicles, ABCP vehicles, money market funds, investment banks, mortgage companies, and a variety of other entities are part of the shadow banking system. Before the crisis, the shadow banking system had come to play a major role in global finance; with hindsight, we can see that shadow banking was also the source of some key vulnerabilities."
Bernanke said, "As was illustrated by the ABCP market meltdown discussed earlier, the reliance of shadow banks on short-term uninsured funds made them subject to runs, much as commercial banks and thrift institutions had been exposed to runs prior to the creation of deposit insurance. A run on an individual entity may start with rumors about its solvency, but even when investors know the rumors are unfounded, it may be in their individual interests to join the run, as few entities can remain solvent if their assets must be sold at fire-sale prices. Thus, fears of a run have the potential to become at least partially self-fulfilling, and a run may blur the distinction between an insolvent and an illiquid firm."
He commented, "Money market mutual funds proved particularly vulnerable to liquidity pressures. A large portion of the investments of these funds were in short-term wholesale funding instruments issued or guaranteed by commercial banks. When short-term wholesale funding markets came under stress, particularly in the period after the collapse of Lehman Brothers, money market mutual funds faced runs by their investors. Although actions by the Treasury and the Federal Reserve helped arrest these runs, the money market mutual funds responded by hoarding liquidity, thus constricting the availability of financing to financial and nonfinancial firms."
Finally, Bernanke told the FCIC, "In a time of panic and liquidity shortages, central banks must be able to provide funding to sound financial institutions. In the United States, the Federal Reserve lacked established procedures to provide short-term funding to shadow banks, such as broker-dealers, money market mutual funds, or special purpose vehicles, so it had to develop programs to provide such funding quickly during the crisis.... However, the Federal Reserve was able to supply liquidity to both banks and nonbanks, through a variety of means, to stem the panic. It auctioned fixed amounts of term funding to depository institutions, which seemed to circumvent the stigma problem. The Federal Reserve also created other facilities, in most cases using its emergency authority under section 13(3) of the Federal Reserve Act, to provide collateralized short-term loans to nonbank financial institutions in situations in which market-based funding mechanisms had broken down."
In another sign that money fund managers are looking to consolidate their fund lineups, Federated Investors, the third-largest money fund manager, has filed prospectus supplements for its Federated Arizona Municipal Cash Trust and Federated Maryland Municipal Cash Trust indicating that these two State Tax Exempt money funds may be liquidated due to their small size. These filing follows last week's move by Goldman Sachs to liquidate its smaller Institutional Liquid Assets (ILA) money funds and move investors into its larger Financial Square money fund family. (See Crane Data's August 26 News "Goldman to Consolidate Fund Lineups, Liquidate Inst Liquid Assets MFs".)
The prospectus supplement for the $48 million Federated AZ Muni Cash Trust (AZMXX), says, "Federated Securities Corp. (FSC), the distributor of Federated Arizona Municipal Cash Trust, a series of Money Market Obligations Trust, and Federated Investment Management Company, the investment adviser for the Fund, have decided to undertake a strategic review of the Fund. The review will encompass options for the Fund taking into consideration the Fund's asset size, the costs to run the Fund, and the Fund's prospects for future growth, with a view toward seeking to terminate the existence of the Fund, through either liquidating the Fund or reorganizing the Fund into another Federated municipal money market fund."
The filing adds, "The Fund intends to continue to process purchases, redemptions and exchanges in the ordinary course of business during the review. The Adviser anticipates that, in the short term, it, and its affiliates, will continue to waive and/or reimburse certain Fund fees and expenses to maintain the Fund's yield at a level similar to the yield of the Fund over recent quarters. It is possible that shareholders of the Fund will redeem their investments prior to the completion of the strategic review. FSC, and its affiliates, will be working with the Fund's shareholders and intermediaries to identify alternative Federated investments."
The $38 million Federated MD Muni Cash Trust (MDMXX) filing says, "Federated Securities Corp. (FSC), the distributor of Federated Maryland Municipal Cash Trust, a series of Money Market Obligations Trust, and Federated Investment Management Company, the investment adviser for the Fund, have decided to undertake a strategic review of the Fund. The review will encompass options for the Fund taking into consideration the Fund's asset size, the costs to run the Fund and the Fund's prospects for future growth, with a view toward seeking to terminate the existence of the Fund, through either liquidating the Fund or reorganizing the Fund into another Federated municipal money market fund."
The MD supplement also adds, "The Fund intends to continue to process purchases, redemptions and exchanges in the ordinary course of business during the review. The Adviser anticipates that, in the short term, it, and its affiliates, will continue to waive and/or reimburse certain Fund fees and expenses to maintain the Fund's yield at a level similar to the yield of the Fund over recent quarters. It is possible that shareholders of the Fund will redeem their investments prior to the completion of the strategic review. FSC, and its affiliates, will be working with the Fund's shareholders and intermediaries to identify alternative Federated investments."
Crane Data's Money Fund Intelligence XLS currently tracks 87 domestic U.S. money funds from Federated Investors with a total of $224 billion. These funds are among the smallest managed by the company.
The Securities & Exchange Commission recently posted a document entitled, "EDGAR Form N-MFP XML Technical Specification (Version 1), which had an "Implementation Date" of August 30, 2010. While we don't claim to understand most of this document (like most things in the SEC's EDGAR database, only a computer programmer can understand it), it was one of the final pieces that fund companies were awaiting before implementing one of the final pieces of the SEC's Money Market Fund Reform, the disclosure of portfolio information.
The original SEC MMF Reforms (see page 72) said, "We are amending rule 2a-7 to require money market funds to disclose information about their portfolio holdings each month on their websites. The disclosure will provide greater transparency of portfolio information in a manner convenient for most investors. The amendment is designed to give investors a better understanding of the current risks to which the fund is exposed, strengthening their ability to exert influence on risk-taking by fund advisers.... As proposed, the amendments to rule 2a-7 would have required a fund to disclose the fund's schedule of investments."
The Rule 2a-7 Reforms explain, "We are adopting a new rule requiring money market funds to provide the Commission a monthly electronic filing of more detailed portfolio holdings information. The information will permit us to create a central database of money market fund portfolio holdings, which will enhance our oversight of money market funds and our ability to respond to market events. As discussed further below, the information will also be made public on a delayed basis. New rule 30b1-7 requires money market funds to report portfolio information on new Form N-MFP."
It continues, "Money market funds must report on Form N-MFP, with respect to each portfolio security held on the last business day of the prior month, the following items: (i) the name of the issuer; (ii) the title of the issue, including the coupon or yield; (iii) the CUSIP number; (iv) the category of investment (e.g., Treasury debt, government agency debt, asset backed commercial paper, structured investment vehicle note, repurchase agreement); ... (ix) the principal amount; (x) the current amortized cost value; (xi) the percentage of the money market fund’s assets invested in the security; (xii) whether the security is an illiquid security (as defined in amended rule 2a-7(a)(19)); and (xiii) 'Explanatory notes.'"
The SEC says, "Form N-MFP also requires funds to report to us information about the fund, including information about the fund's risk characteristics such as the dollar weighted average maturity of the fund's portfolio and its seven-day gross yield. Money market funds also must report on Form N-MFP the market-based values of each portfolio security and the fund's market-based net asset value per share, with separate entries for values that do and do not take into account any capital support agreements into which the fund may have entered. Under rule 30b1-7, the information contained in the portfolio reports that money market funds file with the Commission on Form N-MFP will be available to the public 60 days after the end of the month to which the information pertains."
They added, "In response to commenters, we are delaying the mandatory filing date for several months after the effective date of the amendments, to permit money market funds to develop systems necessary to collect and submit the portfolio information on Form N-MFP. Thus, the first mandatory filing will be due on December 7, 2010, for holdings as of the end of November 2010. For approximately two months before the first mandatory filing, our staff will accept the submission of trial data so that money market funds may voluntarily make (non-public) electronic submissions with us." (These filings will be available to the public starting 60 days later, around Feb. 7, 2011.)
The new EDGAR Form N-MFP posting says, "In support of the adoption of new rule 30b1-7 under the Investment Company Act of 1940 and new Form N-MFP, which were included in the Commission's recent money market fund reform package (See Release No. IC-29132 [75 FR 10060]), the EDGAR system was upgraded to Release 10.3 on August 30, 2010. EDGAR Release 10.3 will deploy new submission types N-MFP and N-MFP/A to facilitate the electronic filing of the new form. Filers must follow the Form N-MFP XML Technical Specification to construct their Form N-MFP and Form N-MFP/A submissions via the EDGAR Filing Web site (https://edgarfiling.sec.gov) or by clicking the 'Are you an EDGARLink filer or would you like to create a new Asset-Backed Securities Issuing Entity?' link from the EDGAR Portal Web site (www.portal.edgarfiling.sec.gov).
It adds, "The following EDGAR Form N-MFP XML Technical Specification documents detail the valid structure and content of the EDGAR Form N-MFP submission types (N-MFP and N-MFP/A)." This page offers a link to: "Download the EDGAR Form N-MFP XML Technical Specification (Version 1) (compressed folder)."
