Fitch Assesses Consequences for Money Market Funds of US Default

Fitch-rated US money market funds (MMFs) hold an estimated US$234.9bn, or about 37% of total assets in exposures to the US government via holdings of US Treasury (UST) and government agency securities as well as reverse repurchase agreements (repos) that are collateralised by such securities, says the credit ratings agency (CRA) in its assessment of the potential impact of a US technical default

In addition, US dollar-denominated offshore MMFs hold a further US$46bn of exposures, of which US$26bn is via repos.

The US Treasury has said that available funds could run out as early as 17 October in the absence of a debt ceiling increase. Fitch still believes that an agreement will ultimately be reached to end the current political impasse in order to raise the US debt ceiling and avoid a ‘technical’ default. Nonetheless, the CRA believes it is worth exploring the potential ramifications for US dollar-denominated MMFs should the US government fail to make timely payments on some portion of its debt obligations.

Fitch believes the overall risk to MMFs due to a US default to be low. Mark-to-market declines on US government exposures are probably manageable, assuming any default is short lived and absent significant redemption activity. In part, this view reflects MMFs’ low weighted average maturities and high amounts of short-term liquidity available to meet redemptions.

Importantly, MMFs would not be required to sell US Treasury securities in the event of a technical short-term default under Rule 2a-7 of the 1940 Investment Act and under Fitch’s MMF rating criteria. Thus, any liquidity pressures would more likely arise from increased redemption activity. So far there is no evidence that investors are taking money out of U.S. MMFs, although this might change as the deadline to raise the debt ceiling nears. US MMFs experienced net outflows of US$8.5bn last week, or roughly 0.3% of the industry’s US$2.694 trillion in assets under management, after mostly rising for several months. In particular, US government MMF assets were flat, while prime MMFs saw outflows of US$11.3bn, and municipal MMFs gained US$2.8bn.

Some of the liquidity MMFs hold, however, is in the form of maturing UST securities and/or short-term repos secured by USTs that help MMFs meet overnight and one-week liquidity requirements. Fitch-rated US MMFs hold US$98.4bn of repos secured by US government securities. Many MMFs rely in part on short-term repos and to a lesser extent direct US Treasury securities as a source of liquidity. A material disruption of the UST-backed repo market would be a credit negative given its size, interconnectedness and importance to MMFs.

Liquidity impact

That said, liquidity levels at prime funds appear reasonably solid, even after stripping out UST-backed repo and maturing UST securities. Based on August month-end data, Fitch-rated prime MMF portfolios held 26% of their assets in positions maturing in one-week or less (one-week liquidity), excluding government securities and repos backed by government securities.

Some government MMFs only invest directly in UST securities and, therefore, are more reliant on a liquid, well-functioning market in order to meet redemptions. If government MMFs were to face heavy outflows, a failure by the US government to rollover maturing UST securities would have a liquidity impact and require the funds to sell longer-dated securities. MMFs with heavy exposure to UST securities maturing in October and early November could be pressured in the face of heavy redemption activity. Fitch understands that many MMF managers have shifted out of US Treasury securities maturing in October that could be most at risk to a debt ceiling impasse.

Fitch’s rating criteria for MMFs would not require funds to sell UST securities that are in a short-term ‘technical’ default, provided that payment is expected to be received imminently, and that the MMF has sufficient liquidity to meet redemptions even when excluding the defaulted UST securities. However, a longer-term impasse could put pressure on of the ability of some MMFs to meet timely redemptions and maintain preservation of capital, consistent with Fitch’s rating criteria for MMFs, which could have negative rating implications.

The CRA added that as events unfold over the next two weeks, it will continue to dialogue with managers of rated MMFs to understand their net inflows/outflows, underlying liquidity positions and contingency risk management plans, as well as the reaction of broader markets to the debt ceiling negotiations.

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