Bank Strains Emerge as Brexit Collides With Money-Fund Overhaulby
Dollar Libor-OIS spread, a sign of funding cost, widens
Cash exits U.S. prime funds, limiting demand for banks’ debt
For U.S. banks, Brexit couldn’t have come at a worse time, raising funding costs just as changes to the $2.7 trillion money-fund industry threaten to sap demand for the lenders’ short-term debt.
In the derivatives market, measures of banks’ funding stress are climbing on speculation the fallout from last month’s U.K. referendum will weaken global economic growth and spur monetary stimulus that may depress yields and undermine earnings in the financial industry. The difference between the rate banks charge each other for dollar loans in London and the overnight index swap rate, known as the Libor-OIS spread, reached about 0.286 percentage point Friday, a level last seen during the 2012 European debt crisis.
Ripple effects from the British vote to leave the European Union are compounding strains that have been building for months as a result of efforts to make the financial system safer. Wall Street strategists predict investors will pull as much as $400 billion from U.S. prime money funds before an overhaul of the industry is completed in October. Those investors are key buyers of banks’ commercial paper.
With prime money funds facing possible outflows, “they aren’t chomping at the bit” for commercial paper, said Priya Misra, head of global interest-rates strategy at TD Securities in New York. “And with Brexit, whatever you thought about the health of banks a month ago, it’s worse now.”
Britain’s decision to leave the EU will probably curtail finance-industry revenue as companies fretting about the economic aftermath may forgo takeovers and share sales, according to Deutsche Bank AG. In the U.S., net interest margins for large banks will decline, according to Oppenheimer.
Italian banks, already saddled with about 360 billion euros ($398 billion) in soured loans, are being hit hardest. Italy’s government has been sounding out regulators on ways to bolster lenders bruised by a renewed selloff after the British vote.
The three-month dollar Libor-OIS spread, a barometer that came to the forefront during the 2008 credit crunch, is still below levels seen during prior crises. It reached 0.50 percentage point in 2012, and soared to a record 3.64 percentage points following the collapse of Lehman Brothers Holdings Inc.
Brexit won’t spark the type of funding squeeze seen in 2008, given support from policy makers, according to Christoph Rieger, head of fixed-rate strategy at Commerzbank AG in Frankfurt. The Bank of England and the European Central Bank are providing or offering liquidity to banks, and the Federal Reserve makes dollar funding available through swap lines to major central banks.
“The markets have seen some relief after the initial Brexit selloff, but this has given way again to second thoughts about what else may come,” Rieger said. “But there is definitely not a funding crisis, but rather solvency issues with regards to a number of Italian banks.”
The ECB and the Bank of Japan tapped the Fed’s swap lines in the week ending July 6th by a total of $2.99 billion, the most since May 2013, Fed data show.
Even if the Brexit fallout is contained, money-fund industry changes are set to put pressure on unsecured bank funding rates, like Libor, Misra said.
The exodus from prime funds started last year as some investment companies converted prime funds into those that only buy government debt -- exempting them from rules beginning in mid-October that require daily net asset values to fluctuate. Now investors are leaving prime funds, to avoid floating NAVs as well as restrictions such as redemption fees.
The funds’ assets have declined about 20 percent this year, or $252 billion, while government-related funds gained $245 billion, or about 21 percent, according to Crane Data LLC figures through June.
Banks’ reliance on commercial paper leaves them in the crosshairs during the money-fund overhaul. The potential for weaker demand from prime funds is contributing to lift financing costs.
Three-month commercial paper rates have risen to about 0.63 percent, from 0.24 percent a year ago.
“June is the first month that we’ve seen noticeable outflow from prime money funds that weren’t conversions-related,” said Peter Crane, president of Westborough, Massachusetts-based Crane Data. “No doubt we will see more.”