The stand-off between big French banks and US money market funds deepened after the summer as managers again cut lending to the sector following rating agency downgrades.
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| cut in US prime fund exposure to banks in France |
According to US MMF data provider Crane, US prime funds cut exposure to French banks by $110 billion, or 46%, between May and September. Declines were particularly acute in commercial paper and certificates of deposits, which dropped 70% and 64% respectively. French bank exposures now account for less than 6% of the total assets of US money funds, down from more than 10% in May.
While Moody’s affirmed BNP Paribas’ Aa2 rating in October, it maintained its negative outlook on the bank, referring, without irony, to its difficulties in accessing wholesale funding markets. The agency downgraded Crédit Agricole (from Aa1 to Aa2) and Société Générale (Aa2 to Aa3). Standard & Poor’s followed suit in October, lowering BNP Paribas from AA to AA–, another modifier downgrade. S&P also announced it had lowered France’s banking industry country risk assessment by one-notch to Group 2. Fitch, meanwhile, announced it had begun a review of French banks’ credit quality.
Negative psychology
According to Dave Sylvester, who heads Wells Fargo’s $125.7 billion money market funds, headlines about rating agency actions on French banks have taken on a life of their own for money market fund shareholders.
"Perhaps the proliferation of rating actions stemming from the upward and downward movement of rating modifiers alone leads to the barrage of news and contributes to the pervasive negative psychology in the markets. After numerous articles about the negative implications of the review of French banks by Moody’s, how many articles heralded the affirmation of BNP Paribas’s rating? It was reported, but not in a series of page-one news stories unfolding over weeks and months," Sylvester says.
Though some fund managers view the risks to French banks as manageable and are glad that the European authorities have now shifted their attention to shoring up the broader financial system, it’s hard to see them moving back into French bank debt soon. "The problem facing Europe is one of contagion, and this contagion is exacerbated by the negative psychology that pervades the markets, especially the money markets," says Sylvester. "We believe that the constant barrage of negative news stemming from relatively minute changes in credit ratings is a significant contributor to this negative psychology. Unfortunately, as seems to be the case with the US economy, the patient’s psychological symptoms may prove harder to cure than the fundamental illness itself.
Resilience
While the flight of money market funds has caused big problems for French banks, the funds themselves are under pressure as regulators try to shore-up their resilience during times of stress. Money market funds’ role as a general source of wholesale funding for debt issuers and a safe haven for investors’ cash appears to be in decline. Both prime and government debt-only funds suffered substantial declines in assets under management over the past 18 months.
Since the collapse of the $60 billion Reserve Fund in 2009 following the Lehman Brothers bankruptcy, US money managers have come under pressure from the Securities and Exchange Commission to run their funds more conservatively to preserve the ‘dollar-in, dollar-out with interest’ commitment to investors. New regulations require funds to hold a greater proportion of their portfolio in liquid assets and to limit the weighted average maturity of portfolios to 60 days, rather than the previous 90-day standard.
Barclays Capital’s US money market strategist Joseph Abate points to recent tenor shortening to less than 40 days and sharp growth in cash-equivalent holdings as evidence of the impact of the new conservatism.
US fund managers have looked to domestic banks, non-financial issuers and government securities markets to fill the void left by reduced supply in the euro commercial paper and certificate of deposit markets, but short-dated government supply has been falling too. Since the beginning of 2011, US Treasury Bill supply has dropped by $270 billion on a combination of fiscal cuts and debt management initiatives. It now accounts for the smallest share of total Treasury debt outstanding since the 1950s, according to US Treasury data. While the Fed’s latest stimulus programme, Operation Twist, is expected to release some $400 billion of Treasury paper with maturities between three months and three years between now and next June, it is not clear how much of these will be money market eligible.
No demand
Money markets across both prime and government sectors could also suffer a lack of demand from corporate investors, who are looking for other safe places to allocate cash stockpiles, including, strange as it may sound, bank deposits.
| "Money market fund managers may end up incrementally increasing real risk to reduce headline risk. Will they someday regret casting aside issuers of fundamentally high credit quality, like the French banks, for the sake of appearances?" |
Abate says that US non-financial corporations are currently sitting on $1.65 trillion of cash-like assets, equivalent to 11% of their overall financial assets, the highest level for more than 30 years. Corporate balances held with money market funds, however, have been shrinking since 2009; they contracted by 7% already this year. Corporate bank deposits, meanwhile, have grown by more than 20%.
With regulatory proposals to address money market investors’ flightiness expected by the end of the year, suitable investments are becoming hard to find. Beyond government issuance, which is constrained, private-sector asset-backed commercial paper and financial commercial paper supply has contracted sharply since the financial crisis. Meanwhile, regulatory demands that banks reduce their funding reliance on short-term debt instruments creates another potential asset sourcing problem.
"At some point, money market fund managers may end up incrementally increasing real risk in order to reduce headline risk," Sylvester says. "At some point, there will be no pure ‘risk off’ trade. Money fund shareholders must ask themselves if this is the outcome that they want to further. Will they someday regret casting aside issuers of fundamentally high credit quality, like the French banks, for the sake of appearances?"