News Archives: August, 2020

The Federal Reserve Bank of New York recently published a "Liberty Street Economics blog entitled, "The Federal Reserve's Large-Scale Repo Program." It explains, "The repo market faced extraordinary liquidity strains in March amid broader financial market volatility related to the coronavirus pandemic and uncertainty regarding the path of policy. The strains were particularly severe in the term repo market, in which borrowing and lending arrangements are for longer than one business day. In this post, we discuss the causes of the liquidity disruptions that arose in the repo market as well as the Federal Reserve's actions to address those disruptions."

The NY Fed piece continues, "As described in this Staff Report, the repo market serves in part to transfer liquidity from cash investors to cash borrowers, with securities dealers acting as intermediaries. In addition, dealers typically finance a substantial portion of their securities inventory through repo. A number of investors, the largest of which are money market mutual funds (MMFs), lend cash to dealers. Other major cash lenders include commercial banks and the government-sponsored enterprises."

It tells us, "Across all segments and collateral types, the repo market is nearly $4.0 trillion in size, with more than $1.0 trillion in overnight Treasury repo alone. The repo market is important given its size and scale as well as its role in providing funding for Treasury debt and other securities. Additionally, the Secured Overnight Financing Rate (SOFR), a broad measure of overnight Treasury repo rates, is the Alternative Reference Rates Committee's preferred alternative to USD LIBOR (the London interbank offered rate)."

The blog explains, "We focus here on the general collateral repo market, in which funding is provided against a broad set of acceptable high-quality collateral, rather than a specific asset. Repo against particular, specified assets is referred to as 'specific-issue' or 'specials' trading. While general collateral repo is typically aimed at borrowing cash against a portfolio of securities, specials trading is associated with obtaining securities."

It also says, "The U.S. repo market suffered severe strains in the second half of March, due in part to the heightened uncertainty related to the coronavirus pandemic, which affected financial markets broadly, and in part to some factors specific to the repo market, such as the increase in dealer inventories and the unwind of Treasury cash-futures basis trades. The Federal Reserve responded by increasing the frequency, offering sizes, and terms of its repo operations and by purchasing a large quantity of Treasury and agency securities in the secondary market, reducing pressures on dealer balance sheets. These operations appear to have been successful in restoring functioning in these important financing markets."

In other news, J.P. Morgan's "June 2020 Taxable money market fund holdings update" explains, "Taxable MMFs saw net outflows in June, with $125bn exiting the fund complex month over month, likely due to tax payments.... Government funds saw outflows of $138bn while prime funds received a net inflow of $13bn, recouping more of their AUM losses from earlier this year.... Dealer repo ex-FICC decreased $97bn month over month, while exposure to FICC sponsored repo decreased $25bn to $111bn in June.... RRP usage was minimal at just $1bn. Given a 5-10bp disparity between bill yields and repo, most MMFs found relative value by investing in bills rather than repo."

It continues, "Government MMFs pared down agencies exposure as well.... For yet another month, bills were the asset of choice for both Gov/Agy and Tsy funds in terms of AUM allocation. Adding in prime funds' holdings, MMFs now comprise 42% of the T-bill market -- near the record high we saw last month.... While the bulk of current bill holdings are concentrated in the very frontend of the curve ... new purchases were focused on the longer end of the bills curve.... The flows into prime funds (+$19bn) in May seem to have mostly found their way into Treasuries and Agencies instead of credit."

The update tells us, "On the benchmark reform front, government MMF Agency FRN holdings continued to be concentrated in SOFR FRNs. We estimate that at month-end these funds held $324bn of SOFR FRNs versus $186bn of non-SOFR floaters.... On the prime side, we have noticed a considerable uptick (+$20bn m/m) in agency SOFR floaters as well.... Much like the pivot prime funds made towards T-bills and away from CP/CD, we suspect this was driven by similar relative value considerations as credit spreads are rapidly tightening. And unlike credit SOFR-based FRNs, the GSE SOFR FRN market is massive and more liquid. On margin, when faced with low yields on bank credit, some managers now see agency SOFR FRNs as a safe and liquid alternative."

It adds, "In June, prime funds continued to de-risk, turning away from credit products and continuing to buy Treasuries.... Bank CP/CD/TD exposures decreased $20bn.... At the individual issuer level, changes were largely idiosyncratic.... Month over month, the weighted average maturity of bank CP/CD held by prime MMFs decreased 3 days to 53 days, while the weighted average life was flat at 83 days.... Swiss banks had the longest WAL at 141 days, followed by Australian banks at 100 days."

Finally, Crane Data published its latest Weekly Money Fund Portfolio Holdings statistics Tuesday, which track a shifting subset of our monthly Portfolio Holdings collection. The most recent cut (with data as of July 31) includes Holdings information from 60 money funds (down 26 from a week ago), which represent $2.017 trillion (down from $2.475 trillion) of the $4.963 trillion (40.6%) in total money fund assets tracked by Crane Data. (Note that our Weekly MFPH are e-mail only and aren't available on the website. For our latest monthly Holdings, see our July 13 News, "July MF Portfolio Holdings: Repo Plunges, Treasuries Break $2.5 Trillion.")

Our latest Weekly MFPH Composition summary again shows Government assets dominating the holdings list with Treasury totaling $1.123 trillion (down from $1.326 trillion a week ago), or 55.7%, Repurchase Agreements (Repo) totaling $411.7 billion (down from $500.3 billion a week ago), or 20.4% and Government Agency securities totaling $299.8 billion (down from $381.5 billion), or 14.9%. Certificates of Deposit (CDs) totaled $67.6 billion (down from $86.3 billion), or 3.4%, and Commercial Paper (CP) totaled $58.2 billion (down from $89.8 billion), or 2.9%. VRDNs accounted for $29.6 billion, or 1.5%, while the Other category accounted for $26.3 billion or 1.3%.

The Ten Largest Issuers in our Weekly Holdings product include: the US Treasury with $1.123 trillion (55.7% of total holdings), Federal Home Loan Bank with $167.2B (8.3%), BNP Paribas with $58.3B (2.9%), Federal Farm Credit Bank with $53.9B (2.7%), Fixed Income Clearing Co with $48.5B (2.4%), Federal National Mortgage Association with $45.2B (2.2%), RBC with $37.6B (1.9%), Federal Home Loan Mortgage Co with $31.5B (1.6%), Mitsubishi UFJ Financial Group Inc with $26.7B (1.3%) and Credit Agricole with $25.7B (1.3%).

The Ten Largest Funds tracked in our latest Weekly include: Goldman Sachs FS Govt ($255.8B), JP Morgan US Govt MM ($186.5B), Fidelity Inv MM: Govt Port ($166.1B), Wells Fargo Govt MM ($142.7B), JP Morgan 100% US Treas MMkt ($114.1B), Goldman Sachs FS Treas Instruments ($93.1B), Morgan Stanley Inst Liq Govt ($89.2B), Dreyfus Govt Cash Mgmt ($88.2B), State Street Inst US Govt ($83.4B) and JP Morgan Prime MM ($83.0B). (Let us know if you'd like to see our latest domestic U.S. and/or "offshore" Weekly Portfolio Holdings collection and summary, or our Bond Fund Portfolio Holdings data series.)

Last week, Euromoney hosted a webinar entitled, "Managing the 24-hour money market," which featured Calastone's Edward Lopez and SSGA's Will Goldthwait. The session, sponsored by Calastone, covered, "The importance of robust, accountable and informed technology in underpinning the money market," and touched on negative yields, European money fund issues and managing cash in the time of Covid. Lopez comments, "We've seen a lot more need for automation. From the Calastone perspective, our core business is automating the mutual fund flow. But what we've seen recently is more of a focus around the specific vertical for institutional money funds. So, while there had been a little bit of automation in that part of the mutual fund space, what we've seen is there has been a drive to automate the trading, reporting and the settlement side of things.... What's come about with Covid and working from home is now you've got Treasury teams and maybe many of you on the call ... working remotely. And while you might have had a manual process that worked well when you were all sitting on the same floor, or in the same office, now that everyone's working from home ... you could start to see [some] risk.... So we've seen ... a lot more requests to automate some of those processes where we've seen a lot of manual activity in the past."

Goldthwait tells us, "I think that my biggest takeaway from the portfolio management side of things has just been the enormous stress test that essentially, we saw.... We saw a live market dynamic that was putting enormous stress on money market funds, and they came through it. There were certainly some tense periods during the latter half of March. I think the best news for clients that are using money market funds is all of this information is publicly available. Clients now have sort of a data set that they can reference to look at money market funds in an incredibly strained environment, and see how they performed, and what the strains were on yields, on NAVs, on shareholder activity. They can use that to make informed decisions going forward on how they want to incorporate money market funds into their cash management process."

He explains, "Being one shareholder in a money market fund, you know you're with many others, and you know that everyone else is watching. So that's certainly one thing that we hear from clients, the fact that they know if they're in a money market fund there's many people just like them. And they're also curious, what one or other corporate treasurers in my particular sector are doing. So we do speak a lot about that. The other sort of layer of oversight we have is the rating agencies. And they're in with oversight, with daily reports that come in and allow them to monitor those money market funds. So that's another layer."

Goldthwait adds, "The amount of public data now that's available on funds due to reform, you know, European domiciled funds, U.S. domiciled funds, is really remarkable. And I think that was a really helpful piece, and has been a helpful piece, during this first half of the year. A client can get more comfortable with exactly what securities are in these funds? Where are the exposures? And then what are the risk metrics? What are the durations? What's the liquidity look like in these funds? And so that's been another comforting thing for clients."

Lopez says, "I mentioned that in a survey that we've done, APAC was looking for automation around settlements.... But other regions around the world, it was getting the reporting and analytics and looking through insights into funds, etc. Getting all of that wealth of information that's out there that you mentioned Will, and just putting it into a format that could be easily consumed by their analytic systems or their TMS (treasury management system). You can absolutely see that folks are comfortable with the investment from a security perspective, but just ensuring that the proper reporting and analytics is something [else]."

Goldthwait comments, "The other thing that we've seen is the flows have been very, very different from 2008. That's a question that we immediately got, starting literally at the end of February, the beginning of March, is 'Uh oh, do we have a 2008 scenario again?' And I think the flows ... in the U.S. of almost $1.1 trillion coming into money market funds were very, very different than what happened in 2008. In 2008, we saw a fund 'break the buck,' and we saw a significant amount of money flow out. I think the shift out of credit strategies in the U.S. and into government strategies in the U.S. has been dramatic. And now, we've got almost three quarters of the AUM held in government money market funds, which has been very helpful in the U.S. and Europe."

He states, "It's a little bit different in euros and sterling ... the majority is held in credit funds and that worked out well in those markets. Clients were satisfied with that exposure. They were comfortable with the credit risk. We didn't see the outflows that we saw in some Prime funds. But even with the outflows in Prime funds, I think overall it was a liquidity crisis, it wasn't a credit crisis. And our head of research continues to stand by the fact that these banks, given all of the reform that went on [the bank] side, still have plenty of capital and liquidity to withstand even the most harsh of economic downturns. So, we still feel comfortable about that from a credit standpoint."

Lopez also says, "We are seeing some of the, particularly in the offshore, some folks that are closing down there LVNAV and then ... focusing all the effort on the government and the CNAV. I'm wondering if that's similar in the States with the Primes?" Goldthwait responds, "Yeah, we've seen two large fund companies in the states decide they are going to exit the Institutional Prime space." (See Calastone's brief, "Automation in MMFs is Now a Must-Have Say Treasurers.")

Goldthwait then comments, "As much as the conversation sometimes does turn towards yield, this move to make sure that you've got all of that liquidity is very interesting. And we had a poll question recently where we asked our clients what would happen if a money market fund yield went negative like it is in Europe right now. Interestingly enough, a majority of folks answered, 'It is what it is.' You know, it's my cash. And even if it's yielding negative, I can pull it out at any time, and that's just the cost of owning cash. I think that's a really important thing because when we were talking with clients in the early days of the ECB implementing a negative policy rate, there were a lot of folks that were trying to reach for yield."

He continues, "I don't have any concerns [about negative yields] in the U.S. The Fed has been very, very clear that their policy rate will not go negative. And so, I think for that to change, you'd need years of a shift in both governors and policy makers as well as sort of market dynamic. For sterling, I think there might be a little bit more risk there.... But again, I think it comes back to sort of recognizing the cost of cash, and just making sure that you maintain that focus on capital preservation and liquidity, and sort of then put yield over here."

Goldthwait adds, "The other thing that I think is interesting to think about is, when you do go negative, there's a big push pull between what the capital markets will provide you in money market funds and then what bank deposits can provide. And we know that there's banks out there that understand relationship as far as the whole picture, and ultimately can choose to set their deposit rate anywhere they want. Money market funds are a market rate of return, we are only going to be able to provide what the market can provide us. And so, in a way, that's comforting. Owners of money market funds know that it will always be a market rate, versus a deposit. But at the same time, it's hard for me to compete when a bank wants deposits. They can set their rates anywhere to get those deposits."

He comments, "From a U.S. standpoint, my personal view is that there's going to be some discussion around revising the regulations. But ultimately, I don't think there will be any changes. In fact, I think the variable NAV on the institutional side, as well as the liquidity buffers [and] transparency all worked out really well. I think the fact that the clients were able to see exactly what was going on. I think those that wanted to leave Institutional Prime funds … in a way, [NAV] was a penalty for leaving."

Finally, Goldthwait tells us, "In Europe there is a scheduled review in 2022; that was actually planned for five years after the announcement of the set of rules that went into effect in 2018. So, we know that's coming up. Two years will be here, honestly, before we know it. So, you can be sure that there's going to be a lot of discussion around that. I think the real question will be the analytics around the LVNAVs and whether that structure for accounting will survive. I think it's probably a little too soon to make judgment on that. But I do think that that will be the key focus. Is, LVNAV really serving its purpose or was it causing greater angst?"

Federated Hermes, the 6th largest manager of money market funds, reported Q2'20 earnings late last week and held an earnings call on Friday. (See the earnings call transcript here from Seeking Alpha.) The company's earnings release explains, "Money market assets were a record $457.6 billion at June 30, 2020, up $124.5 billion or 37% from $333.1 billion at June 30, 2019 and up $6.3 billion or 1% from $451.3 billion at March 31, 2020. Money market fund assets were $344.8 billion at June 30, 2020, up $113.5 billion or 49% from $231.3 billion at June 30, 2019 and up $8.7 billion or 3% from $336.1 billion at March 31, 2020."

It continues, "Revenue increased $39.2 million or 12% primarily due to higher average money market assets, an increase in revenue from alternative/private markets primarily due to the revenue of a previously nonconsolidated entity being recorded in operating revenue beginning March 2020 and higher performance fees. These increases in revenue were partially offset by voluntary fee waivers related to certain money market funds in order for those funds to maintain positive or zero net yields (voluntary yield related fee waivers) and a decrease in revenue due to lower average equity assets.... During Q2 2020, Federated Hermes derived 55% of its revenue from long-term assets (34% from equity assets, 12% from fixed income assets and 9% from alternative/private markets and multi-asset), 44% from money market assets and 1% from sources other than managed assets."

Federated's release adds, "Operating expenses increased $26.9 million or 11% primarily due to increased incentive compensation and increased distribution expenses associated with higher average money market fund assets. The distribution expenses include a reduction resulting from voluntary yield–related fee waivers. During the three and six months ended June 30, 2020, voluntary yield-related fee waivers totaled $20.0 million and $20.4 million, respectively. These fee waivers were partially offset by related reductions in distribution expenses of $18.0 million and $18.3 million, respectively, such that the net negative pre-tax impact to Federated Hermes was $2.0 million and $2.1 million for the three and six months ended June 30, 2020, respectively."

During Q2 earnings call, Federated President & CEO Chris Donahue tells us, "Moving to money markets, assets increased about $6 billion in the second quarter to a record high of $458 billion with growth in money market funds of about $8.7 billion, partially offset by seasonal declines in separate account assets of $2.4 billion. Money market assets reached a high of $483 billion in late May in advance of tax payments, usage of CARE funds and other uses of cash. Our money market share including the sub advised funds at quarter end was 8.1% down fractionally from 8.8% at the end of the first quarter. Now taking a look at recent asset totals and movements; managed assets were approximately $629 billion, including $452 billion in money markets, $80 billion in equities, $75 billion in fixed income, $18 billion in alternative and $4 billion in multi-assets. The money market mutual fund assets were $339 billion."

CFO Tom Donahue comments, "Total revenue for the quarter was up slightly from the prior quarter, due mainly to a higher money market assets generating $30.5 million in additional revenue ... and higher performance fees of $5.4 million, partially offset primarily by money fund minimum yield waivers of $19.6 million.... The decrease in distribution expense compared to the prior quarter was due the impact of minimum yield waivers which reduced distribution expense by $17.6 million, partially offset by an increase of $10.5 million primarily from higher money market fund assets.... The impact of money fund yield-related fee waivers on operating income in Q2 was about $2 million. Based on recent assets and expected yields, the impact of these waivers on operating income in Q3 could increase to about $4 million. Of course multiple factors impact waiver levels and we expect these factors and their impact to vary."

During the Q&A, Money Market CIO Deborah Cunningham says, "As for the Fed moves, they absolutely were extremely helpful during the quarter by changing their repo rates and procedures from a timing perspective that really influenced where overnight rates are and for our government products that can have upwards of greater than 50% in that type of market. It was extremely helpful. So what basically we saw was an increase in the repo rates that we were using on an overnight basis in those funds by let's say seven, eight basis points somewhere in that neighborhood and they have generally kind of leveled off.... So for example, they just as opposed to being down in the one to two to three basis point camp where they spend a good part of the beginning of the quarter and the end of the first quarter. So we have 10% in overnight and an extra nine basis points in repo."

When asked about waivers going forward, Tom Donahue answers, "We mentioned $4 million which would be up from our estimate of $2 million in the third quarter, and we stay very close with Debbie and her team on their forecasts. As I've said before, that's what we use when we project out one quarter. If you were to ask Debbie what's she going to say for the rest of the year and she will say well, the rates will be similar to the third quarter, but probably a little bit lower and that would make our waivers be a little bit higher. But we only like to talk about one quarter."

Regarding bank deposit rates vs. money funds, Chris Donahue says, "Overall, we always like to 'repeat the sounding joy' of the fact that the clients are in there for daily liquidity apart and the yield is a secondary consideration. And this is a cash management service as much as it is an investment. Therefore, [in the] overall long-term, big picture, we are looking at higher highs and higher lows on our charts as the ebb and flow of money market activities change.... And this has been true since we got into this business in the mid-70s."

Cunningham adds, "If you look at most bank deposit rates, they're at a basis point. So there [the lowest] on the totem pole from an earnings perspective. If you look at the gross yields on our money market funds for the government sector, it's about 25 basis points. Gross yields on our prime funds are currently about 37 basis points, so about 12 basis points over [this]. If you look at the growth rate of assets on a year-to-date basis for bank deposits versus money market funds ... bank deposits have grown by a little over 12% [YTD vs. money] market funds in total [at] about 17%. So again, although the numbers on a base -- average or base level are different, the growth rates has been higher in money market products. And I do believe that [is] given very, very, very low rates that are available on bank deposits."

One analyst asks about revenue sharing and fee waivers, and Tom Donahue tells him, "We ... put in a lot of effort, the last time in the low cycle to meet with everybody and work through the sharing arrangement and pro-rata thought process. We were very successful the last time around, and we're still getting asked by our partners for increased participation that they get versus us. But on terms of the waiver sharing, we have not seen any, any issue with our structure and sharing arrangements."

Finally, another analyst asks, "Can provide any color on institutional ... money markets ... shifting into short duration strategies just to get a little bit more income?" Donahue responds, "`It is very, very difficult [to track] and we don't usually make a speech about how many moved from money markets into other products. As you know from history, we deal with most of these clients on an anonymous basis and so we can't exactly track the cash flow."