Money Fund Rules Seen Triggering Commercial Paper JamSridhar Natarajan and Adam Janofsky
Corporate treasurers say a crackdown on money-market funds threatens to squeeze their access to the short-term financing they use for everything from paying the rent to meeting their payrolls.
Companies from pesticide maker FMC Corp. to power generator Great Plains Energy Inc. are preparing for investors to back away from the commercial-paper market after regulations passed last week requiring some money-market funds to let their net-asset values fall below the traditional $1 a share floor. The shift may trigger a retreat from prime funds that are big buyers of the short-term corporate IOUs, precipitating an increase in borrowing costs.
The rules being implemented by the U.S. Securities and Exchange Commission leave the $1 trillion commercial-paper market facing its biggest upheaval since it seized seven years ago amid the global credit crisis. A drop in demand may drive up borrowing costs on the debt, which typically matures in 270 days or less.
“I know the SEC believes others will pick up the slack of the commercial-paper market, but I’m not optimistic about that,” James Gilligan, assistant treasurer at Kansas City, Missouri-based Great Plains, said in a telephone interview. The impact, he said, “will be a contraction of investors, which will reduce the demand for commercial paper, which will drive up borrowing costs.”
About $320 billion to $500 billion may exit prime money-market funds before the new rules become fully effective in 2016, according to calculations by Barclays Plc and Bank of America Merrill Lynch. Those funds hold about 25 percent of their $1.4 trillion of assets in commercial paper, according to Bank of America.
After outstanding debt plunged from a peak of $2.22 trillion in July 2007 amid a crisis of confidence that prompted the liquidation of the 37-year-old, $62.5 billion Reserve Fund, which became just the second money fund to lose money, or “break the buck,” that contributed to a freeze in credit markets, pushing the Treasury Department to temporarily backstop almost all U.S. money funds. Now, issuers see risks for the market to shrink further.
Prime institutional money funds may see $320 billion in outflows, Joseph Abate, a Barclays strategist, wrote in a July 24 report.
Without access to commercial paper markets that have provided Great Plains with more than $1 billion of funding, the power producer would need to tap revolving bank credit lines that have higher interest rates, according to Gilligan.
“Our borrowing costs would be about 500 percent higher than the commercial paper rate,” he said.
A measure of 30-day U.S. commercial paper rates is at 13 basis points, below the 18 basis-point average for the last five years, according to data compiled by Bloomberg. A basis point is 0.01 percentage point.
Gilligan, who is also a member of the Association for Financial Professionals, was one of the signatories of a letter the group sent to SEC Chair Mary Jo White opposing the proposed rule changes to allow fund asset values to float.
“A shrinking commercial paper market could force large, creditworthy companies that are currently able to sell commercial paper into other areas of debt markets,” the association said in the July 22 letter. That was the day before the SEC voted to adopt the rules, with which funds will have two years to comply.
Money funds traditionally have maintained stable share prices at $1, meaning a dollar invested can always be redeemed for $1.
After the Reserve Fund’s share price fell below that level in 2008, it triggered a panic in a market that long guarded the assumption that investors would never lose principal. The crisis calmed only after the Treasury Department temporarily guaranteed shareholders against losses and the Fed began buying fund assets at face value to help them meet redemptions.
The SEC, along with the Fed and Treasury, has ever since pressed to make money funds safer.
The regulator’s rules would also allow boards of directors of money funds to temporarily suspend withdrawals or impose fees when a fund faces an inability to meet redemptions.
Prime money market funds may see outflows of as much as $500 billion over two years, mostly from institutional funds, according to a July 25 report from Bank of America Corp.
“We fear these changes will have a detrimental effect on our commercial-paper program,” Thomas Deas, treasurer of Philadelphia-based FMC said in a telephone interview.
The company had $600 million of commercial paper outstanding at the end of the first quarter, Deas said. “The only other alternative would be direct borrowings from banks, which would be considerably more expensive” at five- to 10 times the cost, he said.
FMC’s average effective interest rate on commercial paper borrowings was 0.34 percent as of Dec. 31, according to a regulatory filing. By comparison, the company pays 1 percentage point more than the three-month London interbank offered rate on a six-year revolving credit line, according to data compiled by Bloomberg. Libor was set at 24 basis points yesterday.
The company, which has a $1.5 billion commercial paper program, will wait to adapt to the rules because they will take two years to take effect, Deas said.
The gradual implementation of the rules is likely to mitigate the effects in the market, said Barclays’s Abate.
“There is some justifiable concern that rates are going to rise but I don’t think you are choking off funding,” he said in a telephone interview. “I don’t think all this money is going to come gushing out or that funding conditions are going to tighten irreparably for financial and non-financial issuers.”
U.S. commercial paper rose $20.4 billion in the week ended yesterday to $1.05 trillion, following four straight periods of contraction that was the longest streak of declines for more than five months, according to the Federal Reserve.
Money-market mutual fund assets have declined from a peak of $3.92 trillion in January 2009 to $2.56 trillion in the week ended July 23, the lowest level in almost a month, according to the Investment Company Institute.
“It will make it more expensive for commercial paper issuers,” Brian Smedley, a strategist at Bank of America, said in a telephone interview. “Given the backdrop for demand from money market reforms, we are highly unlikely to see a rebound in commercial paper outstanding.”