A little-known but significant consequence of the financial crisis is that U.S. money-market funds have been forced to buy European bank debt in dramatically higher proportions.
A combination of U.S. banks issuing less debt and funds looking to diversify has seen European banks play a dominant role in U.S. money-market fund portfolios — and even European debt fears haven’t stemmed the appetite.
The percentage of foreign bank obligations — which are largely European, and include Eurodollar certificates of deposit, Yankeedollar CDs and bankers’ acceptances — in prime money-market funds rose to 11.5% as of July, up from 9.8% a year earlier and 7.9% in July 2008, according to research firm iMoneyNet.
iMoneyNet doesn’t break out time deposits — such as fixed-term savings accounts and certificates of deposit — by geography. But one study at a Wall Street firm estimated that most of those holdings are from European banks, and suggests that European deposits are the single-biggest part of money-market funds’ holdings.
Debbie Cunningham, head of money-markets funds at Federated Investors Inc. FII, +1.10% said the financial crisis pushed funds overseas in two ways: the shock of Bear Stearns Cos. and Lehman Brothers Holdings Inc. going bust meant that fund managers saw greater imperative to diversify more to international holdings, while the recession — and disappearing banks — has shrunk domestic commercial paper supply market as growth has stalled.
Cunningham said she has seen an increase in the use of foreign debt in Federated’s funds, adding the firm typically buys paper from “very large global companies” such as Spain’s Banco Santander SA STD, -2.75% Germany’s Deutsche Bank AG DB, +0.71% or U.K. bank Barclays PLC BCS, +0.85%
Research by Capital Advisors Group also found an increase in foreign exposure, especially to European debt. The authors said that 44% of a typical U.S. prime money-market fund is in non-U.S. financial debt, a figure that jumps to 69% for the larger prime funds.
The percentage of foreign issuers in the U.S. commercial paper market rose from about 21% in July 2007 to around 40% in April, the latest available figures. In the financial commercial paper market, the percentage of foreign issuers spiked to 77% in April from 59% three years ago.
The move into European paper may alarm some investors concerned about the debt situation in the eurozone and the U.K. But funds have avoided any problems so far.
Lance Pan, director of investment research and author of the Capital Advisors study, said that one shift he’s noticed as a result of the spring crisis was that funds were buying paper of shorter duration, and also investing less in smaller banks.
“They used to buy [debt from] second- or third-tier banks, but now [most] exposure is to mega-banks,” he said.
The Wall Street firm’s study noted that at the peak of concerns about European sovereign debt, money funds lowered their exposure to the continent’s banks, but that from May the trend has been to re-renter the market, with holdings now close to peak levels.
Cunningham said Federated’s funds have responded to market conditions not by abandoning Europe, but by shortening the duration of their holdings.
“While we may still be using Barclays or Deutsche Bank, it’s not for one-year exposure, it’s more like six months,” she said. “And if we were holding six-month paper, that’s now three months.”
Connie Bugbee, managing editor at iMoneyNet, said the move into more European — and foreign — debt is a trend that is likely to stick. While some prime money funds are barred by their prospectus from buying overseas debt, she added, those that are able will continue to do so even once the U.S. economic picture improves.