U.S. funds wary of short-dated European bank debt

By John Parry and Richard Leong

NEW YORK (BestGrowthStock) – Europe’s debt crisis and a deteriorating economic outlook are making U.S. fund managers wary of short-dated securities from the region’s banks.

Signs of this growing caution, reminiscent of the aversion to riskier assets seen in the market panic of 2008, are surfacing in the commercial paper market, a vital source of short-term funding for banks and companies.

Investors’ aversion to commercial paper starting in the summer of 2007 was one of the first warning signs that something was amiss in the workings of the global financial system.

Several European banks have found it more expensive to borrow in the market than big U.S. financial institutions. On Thursday, for instance, one-week commercial paper from Spain’s Banco Bilbao Vizcaya Argentaria was trading at a 0.32 percentage point rate, compared with 0.19 percentage point for GE Capital Corp, a trader said.

BBVA has been unable to renew about $1 billion of U.S. commercial paper since early May, The Wall Street Journal reported on Wednesday, citing people familiar with the matter. The report said the bank still has “substantial” funding and deposits in Europe and roughly $9 billion in U.S. commercial paper outstanding.

Money market funds are paring back their exposure both to commercial paper in general, broadly defined as debt maturing in 90 days or less, and their holdings of such debt issued by some European banks, analysts say.

The share of foreign bank obligations within all U.S. non-government taxable money market funds tracked by iMoneyNet has fallen to 12 percent from 14 percent at the start of the year.

“Over the past few months, most portfolio managers are aware there have been problems, particularly in Greece and Spain and Portugal,” said Connie Bugbee, managing editor of iMoneyNet Inc. “Headline risk right now is just so critical.”

A recent bailout for Greece and market concerns about the difficulty of some other European governments servicing their debt loads are making investors nervous about company and bank debt from those countries, U.S.-based analysts say.

Anxious investors have scaled back funding to banks, which in turned decided to tap the currency swap lines that the U.S. Federal Reserve reopened recently in an effort to make dollars available overseas via other central banks.

The Fed said late Thursday it provided $1.242 billion of dollars to foreign central banks in the week ending May 26, with majority of the funds going to the European Central Bank.

GROWING RISKS

Risks arising from fundamental events and the perception of risk based on news have caused U.S. and European money funds to pull back from the more troubled markets like Greece and Portugal, said Roger Merritt, global head of U.S. funds and asset management analysis with Fitch Ratings.

Conversations that Fitch has held over about the past week have shown that money market funds “are not only investing on the basis of fundamental risk but may also invest on the basis of headline risk, so even if they like a credit they may elect not to roll it over,” Merritt said. Some fund managers do not want to have to explain to investors why they are holding securities from European countries that are in the news, he added.

This reluctance to roll over bank debt may be contributing to a decline in the amount of unsecured financial paper outstanding, though analysts say that other factors, including new rules, may be helping to curb the size of the commercial paper market.

Expectations of stricter rules for money market funds should stoke demand for safe-haven Treasury bills in the coming months and this expectation may have already made fund managers more disposed to buy government bills instead of commercial paper, analysts say.

Regulators have sought more safeguards for short-term funds after the demise of Lehman Brothers during the credit crisis resulted in the collapse of a huge money market fund.

Under the new rules, which will become effective next week, regulators will require money market funds to hold more Treasury bills and other liquid investments.

U.S. money market funds have cut back their commercial paper exposure to about 34 percent of non-government taxable money market funds now from 39 percent at the start of the year, according to iMoneyNet.

Overall, the size of the U.S. commercial paper market declined for the second week, the latest data released on Thursday showed. The subsector of unsecured financial commercial paper shrank for the fourth consecutive week, declining by $2.3 billion through May 26 after falling by $38.1 billion the previous week.

Even though analysts are still unsure what these latest declines mean, they are anxious to spot any deterioration in this market quickly, as it served as the proverbial canary in the coal mine before the recent global financial crisis.

“We still don’t have a smoking gun per se, but there is a lot of circumstantial evidence to say that things are still under stress and that some financial institutions are having difficulty finding funding,” said Marc Chandler, global head of currency strategy with Brown Brothers Harriman in New York.

Stock Today

(Editing by Leslie Adler and Dan Grebler)

U.S. funds wary of short-dated European bank debt