Moody's Investors Service released a study entitled, "Money Market Funds: 2012 Outlook and 2011 Review" late last week. It says, "Money market funds will continue to be challenged in 2012 by unsettled credit, capital market, economic and regulatory conditions. Such pressures could be exacerbated by the behavior of confidence-sensitive investors amid the continuation of the European debt crisis and challenging economic conditions in the US, as well as by the final outcomes of our rating reviews of European sovereigns, banks and securities firms with global capital markets operations, and securities supported or guaranteed by these entities, due to their potential regulatory implications."
It explains, "The profiles of prime funds in particular are, and will likely continue to be, characterized by (i) high levels of liquidity, (ii) reduced, and shorter-maturity exposures to European banks, (iii) increased investments in US government securities and Aaa-rated European government issues and (iv) lower portfolio weighted average maturities (WAMs) and weighted average lives (WALs). These factors, combined with active portfolio management, as evidenced by the de-risking of portfolios by fund managers in response to, and in some cases in expectation of, deterioration in market conditions, support our stable outlook for rated money funds in the US and Europe and their offshore jurisdictions."
Moody's Senior VP Henry Shilling writes, "It is our view that if and when the credit quality of eligible securities weakens, at least with respect to rated funds, most money market fund managers will proactively pursue a variety of measures to maintain the credit, liquidity and stability profiles of affected portfolios. Tax-free funds, which are highly liquid, are expected to come under greater credit and supply pressures, while government and Treasury funds are better positioned to weather more challenging conditions."
He also says, "Money market funds are generally resilient to credit degradation within the investment-grade universe as they concentrate on near-term maturities and rotate out of deteriorating credits. That said, these investment vehicles are not entirely insulated from rapidly changing market conditions. While current stresses have been incorporated into our money market fund rating, rating watchlistings or downgrades may be appropriate for certain funds in the event of material deterioration in their credit and/or stability profile due to sovereign and/or banking exposures or other market conditions. In the current environment we are closely monitoring portfolios to assess their risk profiles, their managers' risk mitigation efforts, liquidity positions and fund flows for unusual redemption activity."
Moody's continues, "Beyond portfolio-related considerations, additional regulatory changes to address continuing concerns about the susceptibility of money market funds to runs are likely to be proposed in the first half of 2012. Depending on their nature, further reforms could transform the money fund sector. They could accelerate consolidation in an industry that is already highly concentrated, and lead to elevated contagion risk in the long-term, while increasing near- to intermediate-term protections for investors against loss of principal."
Finally, it states, "This report summarizes the key events of the past year and focuses on the five factors that are most likely to dominate and shape the money fund sector in 2012, much as they did in 2011. They are as follows: Credit conditions. Credit conditions are expected to remain under pressure given continued uncertainties in Europe and the global banking sector as evidenced by the placement on review and assignment of negative outlooks to European sovereigns, banks and securities firms with global capital markets operations, and supported securities such as ABCP programs, VRDNs and VRDPs.... Supply of eligible securities. Further deterioration in credit quality is expected to reduce an already diminished supply of the highly rated instruments in which prime funds and tax-free funds, and to a lesser degree, US Treasury and government funds, invest.... Name and sector portfolio concentrations. Prime money market funds are highly concentrated in securities issued by financial institutions, in general, and banks, in particular.... Low interest rates.... [and] Regulatory developments. Regulatory initiatives by the Securities and Exchange Commission (SEC) to address "run risk" associated with money market funds are expected to be proposed this year. Further regulation could transform the money market fund industry."
