Citi writes on "Potential new VRDO supply and its impact on tax-exempt money markets" in a new "Short Duration Strategy" piece. Authors Vikram Rai, Jack Muller and Loretta Bu explain, "Money market funds (MMFs) have been through a rough patch with a long period of ultra-low short rates, which challenged profitability and unfriendly regulations (for e.g. money market reform). Now, with higher short-term rates, the profitability of this industry is less of a worry. In fact, ever since the financial crisis, we have never been as optimistic about the future of this industry as we are now." We review their latest update below, and we also summarize our most recent Weekly Money Fund Portfolio Holdings.
They tell us, "Tax-exempt MMFs, much like prime funds, witnessed a sharp shrinkage in assets due to money fund reform. However, supply in the tax-exempt MMF sector has also shrunk due to reduced VRDO and TOB issuance and thus SIFMA has generally traded rich vs. taxable money market rates such as Libor. But, we see the potential for more VRDO supply this year and while this could cause some volatility in the SIFMA resets, we definitely view it as a positive for the tax-exempt MMF industry. We discuss."
Rai and colleagues say, "As we noted, tax-exempt MMFs faced a more unique problem, that of diminishing investible paper since VRDO and TOBs outstandings, which form a large portion of supply in this sector, have been shrinking. As a result, the SIFMA index was stuck in low single digits for a very long time ... and this further reduced demand from crossover buyers of VRDOs. However, the VRDO supply patterns might finally change this year."
They comment, "At present, US commercial banks, in aggregate, hold about $180 billion in municipal loans (via direct placements) on their balance sheets. Many directly placed loans have a formulaic Libor (or other) index rate language that automatically applies a multiplier based on the changes in the top corporate tax rate.... Given the increased cost associated with directly placed loans, issuers would likely consider more cost effective methods of financing. While converting directly placed loans to fixed rate bonds is a possibility, it is more likely that issuers look for more cost effective variable rate financing to replace these loans."
Citi states, "Of these alternatives, we view LOC backed VRDOs as the most viable option and that is why we expect some directly placed loans to be converted to VRDOs. Even if 25% of the outstanding directly placed loans are converted to VRDOs, it will amount to $45 billion in new supply."
The brief continues, "Municipal investors are well aware of the seasonality in the SIFMA index around tax time. Money market funds and especially tax-exempt money market funds witness outflows around tax season as investors tend to sell their near cash alternatives in order to pay their tax bill.... After the tax deadline, the resets tend to drop slightly but the levels around May 15th still tend to be much higher vs. March 15th. Essentially, we see that the SIFMA index stays elevated about 1 month before and one month after the tax deadline. Thus, given that tax-exempt MMFs are the biggest buyers of short-term tax-exempt paper, new VRDO supply would see better demand when these funds are NOT witnessing outflows."
It tells us, "If we look at the supply demand equation, we find that the aggregate AUM for tax-exempt MMFs is about $134 billion and crossover investors (taxable and non 2a-7 buyers) account for almost half (45%) of the overall demand for short-term tax-exempt products. Thus, given that crossover investors such as prime funds are not equipped to pass on the benefit of tax-exemption to their investors, they become interested in VRDOs only when rates on SIFMA based products are at least in the same territory as comparable taxable rates (for instance, 1wk or even 1m Libor)."
Citi also says, "[I]f the new VRDO supply comes at a slow and steady pace, we expect that demand from tax-exempt MMFs will grow to meet this supply and SIFMA rates (and ratios) will witness a measured increase. By our estimates, additional VRDO supply at a monthly average of $2-$4 billion is unlikely to cause the dreaded reset spiral as this amount can be absorbed by the traditional investor base. This number would have been higher in the pre-MMF reform period as prime funds then had the nimbleness and the capacity to take advantage of any cheapening in the market. On the other hand, if the new supply is large and lumpy, the SIFMA reset is likely to rise until the yield ratios become attractive enough to entice crossover demand."
Finally, they ask, "So, would new VRDO supply bode well for the tax-exempt money market?" Citi's piece answers, "Undoubtedly, after all, there is no story without supply! The shrinking universe of investible paper in the tax-exempt money market space had led to a vicious feedback loop of lower tax-exempt money market rates and shrinking tax-exempt MMF assets. Increases in supply will likely lead to a commensurate increase in SIFMA resets and serve to break this vicious feedback loop. Even if the new supply is large and lumpy, the spike in SIFMA resets will be temporary as we expect that with a flat yield curve and generally higher effective rates post TCJA, there is more than enough demand for short-term paper from the traditional municipal investor base."
In other news, Crane Data published its latest Weekly Money Fund Portfolio Holdings statistics and summary yesterday. Our weekly holdings track a shifting subset of our monthly Portfolio Holdings collection, and the latest cut (which was thinner than usual with data as of March 30) includes Holdings information from 61 money funds (down 15 from 3/23), representing $979.4 trillion (down from $1.404 trillion on 3/23) of the $2.967 (33.0%) in total money fund assets tracked by Crane Data. (For our monthly Holdings recap, see our March 12 News, "March Money Fund Portfolio Holdings: Treasuries Jump, Repo, CD Down.")
Our latest Weekly MFPH Composition summary shows Government assets dominating the holdings list with Repurchase Agreements (Repo) totaling $298.1 billion (down from $458.2 billion a month ago), or 30.4%, Treasury debt totaling $352.8 billion (down from $503.7 billion) or 36.0%, and Government Agency securities totaling $211.7 billion (down from $293.0 billion), or 21.6%. Commercial Paper (CP) totaled $38.3 billion (down from $51.2 billion), or 3.9%, and Certificates of Deposit (CDs) totaled $31.9 billion (down from $37.7 billion), or 3.3%. A total of $19.7 billion or 2.0%, was listed in the Other category (primarily Time Deposits), and VRDNs accounted for $26.9 billion, or 2.7%.
The Ten Largest Issuers in our Weekly Holdings product include: the US Treasury with $352.8 billion, Federal Home Loan Bank with $167.3B, BNP Paribas with $48.3 billion, Federal Farm Credit Bank with $31.4B, RBC with $26.0B, Nomura with $21.1B, Sumitomo Mitsui Banking Co with $19.5B, Wells Fargo with $17.3B, HSBC with $17.0B, and Natixis with $15.8B.
The Ten Largest Funds tracked in our latest Weekly include: JP Morgan US Govt ($126.5B), Fidelity Inv MM: Govt Port ($100.6B), Goldman Sachs FS Govt ($93.9B), Wells Fargo Govt MMkt ($72.4B), Dreyfus Govt Cash Mgmt ($63.8B), Goldman Sachs FS Trs Instruments ($53.5B), Morgan Stanley Inst Liq Govt ($44.0B), JP Morgan Prime MM ($37.6B), Dreyfus Treas Sec Cash Mg ($35.0B), JP Morgan 100% US Trs MMkt ($34.4B). (Let us know if you'd like to see our latest domestic U.S. and/or "offshore" Weekly Portfolio Holdings collection and summary, or our Bond Fund Portfolio Holdings data series.)
