The $400 Billion Money-Fund Exodus With Banks in Its Crosshairs

Updated on
  • Push to make money markets safer transforms industry
  • Investors set to exit prime funds, which buy commercial paper

A view of Royal Bank in Toronto, Canada.

Photographer: Reynard Li

Banks and other companies that have seen borrowing costs rise in the past year are about to feel more pressure in a $1 trillion market for short-term IOUs.

Investors are poised to pull as much as $400 billion from U.S. money-market funds that buy such debt, known as commercial paper, JPMorgan Chase & Co. predicts. The looming exodus, a consequence of steps to make money markets safer after the financial crisis, is set to accelerate before October. That’s when Securities and Exchange Commission rules take effect mandating that so-called institutional prime funds, among the main buyers of commercial paper, report prices that fluctuate. Traditionally, those funds have stuck to $1 per share.

Wall Street strategists say investors may already be shifting from prime funds to those focused on government debt, which will keep a fixed share price. The diminished appetite for commercial paper is a potential headache for banks and other issuers, which saw the cost of the IOUs climb to an almost four-year high in recent weeks. The companies use the instruments for everything from loans to payrolls.

Commercial-paper “issuers will either have to find other investors to fill in the gap, or may have to raise the rate they are offering to get additional interest,” said Gregory Fayvilevich, an analyst in the fund and asset management group at Fitch Ratings in New York.

Next Wave

The move by investors is the next big wave of cash to leave prime funds because of the new rules. It would come on top of about $250 billion of assets that U.S. money-fund companies have already converted over the last year from prime funds to those that only hold government securities like Treasury bills. The SEC measures will force institutional prime funds to tell clients daily whether their investments gained or lost value.

The money-market industry’s changing landscape has already lifted companies’ short-term borrowing costs: Rates on six-month commercial paper reached the highest above Treasury bills since 2012 this year as demand waned relative to government debt. The six-month Treasury bill rate was about 0.45 percent, compared with 0.82 percent on similar-maturity commercial paper.

Financial firms’ short-term debts, including commercial paper, certificates of deposit and time deposits, make up U.S. prime funds’ biggest holdings. Bank of Tokyo-Mitsubishi UFJ Ltd., Credit Agricole SA, Sumitomo Mitsui Bank Corp., Royal Bank of Canada and DNB Bank ASA comprise the top five issuers of this debt held by the funds, according to Crane Data LLC.

Longer maturities and more diversification are part of the answer at Credit Agricole CIB, said Oskar Rogg, head of Treasury for the Americas in New York. “We certainly do have a lot with prime funds. But in terms of our relative dependence on that for funding our core assets,” it isn’t high.

Diversified Approach

Mitsubishi UFJ has also diversified the way it raises funds, including by acquiring foreign-currency deposits, according to Kazunobu Takahara, a spokesman in Tokyo. Sumitomo Mitsui plans to keep commercial paper as an option and aims to prioritize foreign-currency financing, said Takafumi Sasaki, a Tokyo-based spokesman.

Sandra Nunes at Toronto-based RBC and Even Westerveld at Oslo-based DNB declined to comment.

Issuers have other options as money-fund demand for commercial paper dwindles, including the market for repurchase agreements, where they borrow cash temporarily using securities as collateral, according to Joseph Abate, a money-market strategist at Barclays Plc in New York.

Banks are finding it more expensive to borrow across all maturities. Their average borrowing costs on longer-term debt are near the highest in more than two years, according to Bank of America Merrill Lynch indexes. Slowing economic growth is fostering concern that global central banks will keep interest rates low, crimping financial firms’ profits.

Swelling Holdings

With fund companies converting or closing prime offerings, the industry’s holdings of government securities have swelled. Taxable money-funds’ investments in government obligations rose to $1.47 trillion as of the end of January, from $1.18 billion in February 2015, according to Crane.

Estimates vary for the size of the next wave, when investors yank cash from prime funds. JPMorgan projects it will reach about $400 billion this year, while Barclays anticipates about $300 billion.

Peter Crane, president of the Westborough, Massachusetts-based firm that tracks the industry, expects that only about $250 billion will leave prime funds, because he predicts investors will still favor the higher rates on those products and given his expectation that net asset values of prime funds will remain stable. Institutional prime funds’ seven-day yield was 0.21 percent as of Jan. 31, compared with 0.1 percent for government funds, Crane data show.

‘High Demand’

Even at the lower amount that Crane predicts, the flow of funds may push up borrowing costs on commercial paper relative to Treasury bill rates, which have crept up from near zero after the Federal Reserve’s December liftoff.

“Government securities will be in high demand, depressing the yields there, and the demand for credit instruments will be smaller,” said Peter Yi, Chicago-based director of short-term fixed income at Northern Trust Corp., which manages $875 billion. “As that happens, we’re forecasting spreads between commercial paper rates and government securities to widen.”

The SEC joined the Fed and the Treasury Department in moving to buttress money funds following the collapse of the $62.5 billion Reserve Primary Fund after bets on Lehman Brothers Holdings Inc. debt soured. The fund’s failure triggered a run on other money funds and brought the market for commercial paper, worth $1.76 trillion at the time, to a standstill. The market has since shrunk to about $1.1 trillion, with U.S. money funds holding about $380 billion, Crane data show.

The new regulations give investors a bundle of incentives to dump prime funds. In addition to forcing institutional prime funds’ net asset values to float daily based on underlying holdings, the rules will also allow the funds -- for both retail and institutional holders -- to take steps such as temporary fees on withdrawals to reduce runs.

The commercial paper market may shrivel by an additional 15 percent, according to Abate at Barclays.

He had originally expected the migration of money to take place next quarter. But with global financial-market turmoil sparking concern over the health of banks and traders trimming bets on Fed rate increases, investors may have little reason to wait, he said.

“The market is going to contract and yields are going to get higher," he said.