Two Money Funds Propped Up to Forestall SIV-Related Losses

We had noted earlier that one of the motivations for launching the SIV rescue plan sponsored by Citigroup, JP Morgan, and Bank of America wasn’t only to help save the banks who sponsored SIVs from having to tie up their balance sheets by extending funding to them, but also to save money market funds from damage.

SIVs have been having trouble issuing commercial paper because investors have well-founded doubts about the quality of their assets, If an SIV were to liquidate, it is likely that any commercial paper that was still outstanding would suffer a loss.

If the holder is a money market fund, that’s a big deal. Money market funds are required to invest in safe, liquid assets. While not a regulatory requirement, the industry has always presented itself as maintaining a $1 net asset value rule to overcome investor worries about putting funds in unguaranteed accounts. Thus the few times money market funds have looked like they might take a hit (“break the buck,” in industry lingo), the parent company has stepped in to lend a hand. And that is happening now at Legg Mason and Sun Trust, as this Bloomberg story indicates. This follow an earlier salvage effort by Wachovia for one of its funds.

Note that eight of the top ten money market managers have SIV exposure in funds, and those holdings tend to be concentrated in a few funds.

Also note that this is another sign that the proposed rescue plan may come too late to do much good. These firms are having to act now, and as mortgage securities and CDO downgrades proceed, other SIVs may have to liquidate.

From Bloomberg:

Legg Mason Inc. and SunTrust Banks Inc. are propping up money-market funds to cushion them from possible losses on debt issued by structured investment vehicles.

Legg Mason invested $100 million in one of its money funds and arranged $238 million in credit for two others, the Baltimore-based company said in a Nov. 9 regulatory filing. SunTrust Banks Inc. received approval from regulators last month to protect two money funds that bought debt from Cheyne Finance Plc if the SIV is unable to repay the Atlanta-based bank.

The 10 largest managers of U.S. money funds have $50 billion in SIV debt, some issued by vehicles such as Cheyne that defaulted because of losses from securities linked to subprime mortgages, according to reports from the companies. At least three companies — Legg Mason, SunTrust and Wachovia Corp. of Charlotte, North Carolina — have stepped in to make sure their funds don’t “break the buck,” or fall below the $1 a share net asset value that all funds strive to maintain.

“This is the first real case” of securities held by money-market funds defaulting, said Peter Crane, founder of Crane Data LLC, the Westborough, Massachusetts-based publisher of the Money Fund Intelligence Newsletter.

Money funds, considered among the safest investments, loaded up on asset-backed commercial paper with the hope of increasing returns. Asset-backed commercial paper maturing in 90 days yielded an average 5.3 percent this year, 0.6 percentage point more than Treasuries with similar maturities, data compiled by Bloomberg show.

Now, managers including Bank of America Corp., Federated Investors Inc. and Fidelity Investments are trying to limit losses by backing a plan coordinated by the U.S. Treasury for an $80 billion fund to keep SIVs afloat.

“It could be the impetus behind Treasury in this whole process,” said William O’Donnell, head of U.S. rate strategy at UBS Securities LLC in Stamford, Connecticut. “They’re not talking about it. They don’t want to say, `We’re doing this to save the money funds.”’

The SIV crisis has raised questions about whether the debt vehicles are appropriate investments for money-market funds. Vanguard Group, the fifth-largest U.S. manager of money funds, shunned them as too risky. New York-based Goldman Sachs Group Inc., the world’s most profitable securities firm, dumped SIV debt on expectations the vehicles would be hurt by losses on subprime-mortgage securities…

The most recent disclosures by the 10 largest money-market fund managers show that eight of them held a combined $49.8 billion in SIV commercial paper or medium-term notes. Their holdings were mostly limited to a few funds permitted to buy debt issued by the vehicles.

Funds run by Legg Mason held about $10 billion of SIV debt, accounting for 6 percent of the company’s money-market assets at the end of October, according to its filing with the SEC….

Money funds are regulated in the U.S. by the SEC and are considered the safest investments outside of insured bank accounts and government debt. They are required to hold debt that matures in 13 months or less, with a weighted average maturity of 90 days or less. The securities must have top short- term corporate debt ratings

The only money-market fund to fail was run by Community Bankers Mutual Fund in Denver. It paid investors 96 cents on the dollar in 1994 after investing in securities that defaulted…

Wachovia, the fourth-largest U.S. bank, reported last month a $40 million loss on asset-backed commercial paper it purchased from its Boston-based Evergreen Investment Management Co. unit.

Evergreen’s $7.2 billion Money Market Fund cut its holdings in asset-backed commercial paper to $1.76 billion as of Sept. 30 from $2.9 billion six months earlier, according to disclosures on the firm’s Web site. The fund held $100 million in medium- term notes from London-based Gordian Knot Ltd.’s Sigma Finance Inc.

Ten funds run by Pittsburgh-based Federated had $5.75 billion in SIV debt, as of Sept. 28, or 8.6 percent of their assets, according to disclosures on the company’s Web site. Of the four SIVs whose debt Federated owned, two of them have “absolutely no subprime exposure,” Deborah Cunningham, chief investment officer at the Pittsburgh-based company, said on a conference call with investors last month. The other two have less than 1 percent in subprime assets, she said.

Fidelity’s money-market funds held $6.51 billion of commercial paper and medium-term notes sold by SIVs including Sigma Finance, according to disclosures on the Boston-based firm’s Web site. That represented about 3.5 percent of six funds.

“We can state unequivocally that Fidelity’s money-market funds have continued to provide safety and security for our clients’ cash investments,” spokesman Alexi Maravel said in an interview.

Vanguard of Valley Forge, Pennsylvania, steered clear of SIV debt because it has “little or no” backstop financing from banks, David Glocke, manager of the closely held firm’s $97 billion Prime Money Market Fund, said in an e-mail.

“Without established bank lines that the SIVs can access to cover funding disruptions, they’re at the mercy of the market,” he said.