U.S. money market funds are increasing their investment in repurchase agreements, and that’s a trend unlikely to change anytime soon, according to a October 4 report by Fitch Ratings, the credit rating service.
Repo activities by U.S. prime money market funds totaled $281.5 billion at August 31, up from $170 billion March 31. The August 31 level represented 17 percent of total assets under management, up from an historical average of 11 percent, Fitch reported. For U.S. government money market funds, the historial average is 42 percent.
Prime money market funds are funds that invest in corporate instruments in addition to government securities, hoping to achieve a better return. They have traditionally viewed repos as their main overnight liquidity management tool, said Fitch. In general, mutual funds, including money market funds, use repos as a way to invest.
Points from the Fitch report:
-Fitch-rated taxable money market funds, both prime and government, on average lend 24.4 percent of their total assets on the repurchase market. About 82 percent is loaned overnight.
-Because of low yields and a shortage of government securities, some U.S. prime money market funds are moving to longer-term repos and repos backed by nongovernment collateral.
-Fitch-rated taxable money market funds conduct repos through the tri-party market, which is concentrated. The funds’ 10 largest repo borrowers account for more than 82 percent of the funds’ repo exposure. The 10 are, in declining order, Barclays Bank, Deutsche Bank, BNP Paribas, Bank of America, Goldman Sachs, Royal Bank of Scotland, Credit Suisse, Citigroup, Societe Generale and Toronto-Dominion Bank.
-Fitch estimates that one-fourth of the tri-party repurchase market is repo loans made by U.S. taxable money market funds, which totaled $446 billion at March 31.
From the report:
The current historically high level of investments in repos can be attributed to a combination of factors, including uncertainty regarding the future direction of short-term interest rates, a shortage of money market fund-eligible securities resulting in lack of investment opportunities, and the new liquidity rules introduced by the SEC requiring taxable money market funds to hold at least 10 percent in assets maturing daily or U.S. Treasury securities.
More recently, some money market funds have begun to reintroduce exposures to repos backed by nongovernment securities (nongovernment collateral) as a means of increasing fund yields. In addition, given continuing contraction in eligible assets supply, money market funds may choose to invest in nongovernment collateral repos as a means of increasing available investment opportunities.
Fitch has observed a slight increase in use of term repos with maturities exceeding seven days. Fitch also notes that the use of illiquid securities, including term repos with maturities exceeding seven days, is limited by money market fund regulation to five percent of the fund’s total assets. … Term repos provide income opportunities as funds receive increased compensation for the reduced liquidity of such agreements.
The Fitch report makes a couple of interesting points about money market funds and their repo loans:
-They may use a seven-day put to a term repo agreement as a maturity shortening provision to avoid reporting such an investment as illiquid. In other words, they would buy the right to sell the repo at a specific price in up to seven days.
-They often conduct repos with unrated wholly owned subsidiaries of rated financial institutions, and normally Fitch treats the subsidiary as though it had the rating of the parent company.
Repos continue to be an important asset class and a liquidity management tool for money market funds. Given the recent regulatory changes, which impose additional liquidity and maturity constraints on U.S. money market funds, the use of overnight repos has become increasingly important. In addition, in the environment of declining availability of high credit quality, short-term investment options, Fitch would expect money market funds’ investments in repos to increase.