Money market fund managers have been dealing with a decline in short-dated, high quality investments since 2007, and that decline is likely to continue through into next year, Moody's Investors Service said on Monday. On the supply side, there has been a reduction in available product due to dislocations in the short-term structured securities market, as well as reduced short-dated issuance from key sectors like financial institutions.
In addition, regional liquidity pressures have throttled supply for euro-denominated money market funds, Moody's said in a note to clients. At the same time, money market funds are being impacted on the demand side by more stringent regulatory requirements and by self-imposed limits to mitigate against the risk of not satisfying investor demand for liquidity, Moody's said.
However, it said several trends are emerging in the sector that could offset the decline in short-dated, high quality investments. They include intensified pursuit of collateralised lending like repurchase agreements backed by triple-A rated sovereign debt, and increased potential for corporate commercial paper issuance. "We believe that these trends could partially offset the challenges to the sector described above, though the overwhelming reduction in supply of qualifying assets will remain a real issue for the sector well into 2012," Moody's said in the note.
Prior to 2008 and the credit crisis, money market fund managers invested in asset-backed commercial paper that included aggressive instruments such as structured investment vehicles. But since 2007, a few fund managers have withdrawn from asset-backed commercial paper altogether, and most have restricted asset-backed commercial paper investments to "fully supported, bank-sponsored multi-seller programs with short tenors," Moody's said.
"Similar to bank CP issuance, the asset-backed commercial paper market has experienced 'tiering,' where larger conduits could issue paper with relative ease, while smaller conduits backed by lower credit quality financial institutions found it difficult to issue. The effect is a reduction in the number of available conduits that meet the quality criteria of the money market funds' credit teams," the ratings agency said.
The supply/demand impact is not limited to asset-backed commercial paper, Moody's said.
"Supplies of short dated tax-exempt securities, in particular municipal variable rate demand notes, have also been constrained. While there was an uptick in the last quarter of 2010, variable-rate demand notes issuance in 2010 totalled $26.7 billion, 25 percent below the $35.6 billion issued in 2009," Moody's said.
Fitch Ratings said last week that US money market funds slashed their holdings of French bank securities in September due to fears over their high exposure to Greece, which is at risk of default. Fitch said prime money market funds it tracks scaled back their exposure to short-term debt issued by French banks to 6.7 percent of their total assets at the end of September, a 42 percent drop from 11.2 percent at the end of August.
The funds reduced their overall asset exposure to European banks by 14 percent in September from August, it said. Fitch based its analysis on 10 of the biggest prime funds with combined assets of $654 billion at end of September. They represent about 45 percent of the $1.47 trillion in assets managed by all prime money funds. Prime funds represent a tad more than half of the $2.6 trillion US money fund industry.