Big European and American banks have found a productive place to park the energy sector’s
most distressed debt: the $2.7tn US money market industry.
Barclays Bank, Credit Suisse and Wells Fargo and others get overnight and short-term loans
from companies that run money market mutual funds such as Fidelity Investments, BlackRock,
American Beacon and others. The banks use the money to fund long positions in securities
or to cover short positions. For collateral, the funds are accepting the junk-rated bonds
of beat-up energy companies.
Even though the value of the bonds are in free fall as oil prices plummet, the money funds
readily accept the debt, because it’s a way to generate above-market yields in an industry
hurt by near-zero interest rates. In 2014, the average yield for taxable money fund
investors was a paltry 0.01%. Banks currently have about $90bn outstanding in short-term
and overnight loans backed by riskier assets that include corporate debt and equities.
The exact amount of junk-rated energy debt used as collateral was not available. But more
than a dozen of the sector’s mostly highly distressed issuers, including QuickSilver
Resources, Black Elk Energy, Halcon Resources, Samson Investment and Sidewinder Drilling
Inc, have had their bonds used as collateral, according to recent fund disclosures.
These so-called “other repurchase agreements” generate above-market yields for the funds,
ranging anywhere from 20 basis points to 50 basis points. In contrast, repo loans backed
by safe US Treasuries can generate yields of about 10 basis points and less, according to
recent fund disclosures.
Most money fund assets are in Treasuries, certificates of deposit and government agency
debt. But some jarring discoveries in the types of collateral money funds accept on
short-term loans to big banks can be found by investors who dig through industry
A money fund run by Morgan Stanley recently disclosed, for example, an $8.25mn repurchase
agreement with Credit Suisse, which used bonds issued by Sidewinder Drilling as most of
the collateral. As oil prices have tumbled, so has the value of Sidewinder’s 2019 bonds,
falling about 44% since early October.
Credit Suisse declined to comment.
Money funds downplay the risk in the repo transactions backed by the junk-rated
collateral. They say their ultimate backstop is the bank on the other side of the deal.
Fidelity, the largest money fund operator in the industry, declined to comment on any
specific transaction. In a statement, the company said, “We make an independent assessment
on the counter-party credit quality in all repurchase agreements to ensure the counter-
party represents minimal credit risk.”
By contrast, No 1 US mutual fund company Vanguard Group plays it safe. The $133bn Vanguard
Prime Money Market Fund and the company’s other money funds only accept US government
securities as collateral, company spokesman David Hoffman said.
“In times of stress, governments are far more liquid than other asset classes,” Hoffman
said. “This is especially true with US Treasuries, which are likely to rally during times
Federal Reserve Bank policymakers say they are worried that some banks rely too much on
repo loans as a source of wholesale funding. They also point out how money funds make
loans secured by assets they would quickly unload if the bank on the other side of the
“What always worries you about wholesale funding is the run risk,” John Williams,
president of the Federal Reserve Bank of San Francisco, told reporters this week at an
economic conference in Boston. “... Heavy reliance on wholesale funding, which is still
there for certain institutions, is an important issue that we need to address and make
sure our financial system is resilient to things going wrong.”
Despite a host of new regulations for money funds and banks, some of the same elements of
risk that led to a redemption run in the money fund industry and the failure of Lehman
Brothers in 2008 remain intact. Treasury and Federal Reserve officials say more work needs
to be done to address the risks of asset fire sales and redemption runs.
A redemption run on the Reserve Primary Fund in 2008 has been a rallying cry for reform
after its exposure to Lehman Brothers debt prompted panicked investors to withdraw their
money in droves. That run led the fund to “break the buck,” a rare event in the money
market fund industry that refers to a fund’s net asset value falling below $1 per share.
In recent presentations, Boston Fed President Eric Rosengren has said there should be more
disclosure about the composition of the collateral used in repo agreements. He said it
would allow investors an opportunity to observe changes in financing patterns and might
prevent risk taking that investors may consider excessive.
And this summer, before oil prices began their descent, bonds issued by Black Elk Energy
Offshore Operations were used as collateral in repo agreements with funds run by Fidelity,
BlackRock Inc and Goldman Sachs’ investment management arm, fund disclosures show.
But in recent months, Black Elk debt maturing later this year is not turning up as
collateral in the latest round of money fund disclosures. The yield on its bonds has
spiked as high as 75% in the past month, an indication of the bond market’s dimming view
the company can avoid default.
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