Bank Failures Rattle Market for Short-Term Lending

“Our market completely froze,” said Ryan Weldon, portfolio manager of the IFM US Dollar Liquidity Fund, which invests in highly rated, short-term corporate debt through commercial paper and certificates of deposit, known as the CP/CD market.

Prime money-market funds, those that invest primarily in CP/CD, help fund domestic banks. Of the nearly $1.2 trillion invested by prime funds before the March banking turmoil, $125 billion was in U.S. financial institutions, Office of Financial Research data show. Debt from JPMorgan Chase & Co., Corp. and Inc. comprised about half of that total.

Foreign banks tap CP/CD markets to borrow U.S. dollars. Prime funds had roughly $575 billion invested abroad as of the end of February. Another $336 billion of prime fund assets are parked at the Fed’s reverse repo facility.

Other companies use commercial paper to fund their day-to-day activities, such as paying employees. Prime funds have roughly $16 billion in U.S. nonfinancial commercial paper.

Rates on the highest-rated 90-day commercial paper—issued by blue-chip borrowers including New York Life Insurance Co., Johnson & Johnson and Co. —rose to 0.2 percentage point above the benchmark three-month secured overnight financing rate, or SOFR. Those rates have since narrowed closer to the benchmark, according to IFM Investors’ analysis.

Meanwhile, yields on paper considered to be highly rated—one notch down from the safest securities, issued by foreign banks such as BNP Paribas and Crédit Agricole in recent weeks—surged more than 0.3 point above the three-month SOFR. Those rates remain well-elevated relative to the negative spreads seen before the banking turmoil.

New York Life keeps roughly $500 million in the commercial-paper market at any given time, “keeping their name familiar” should the company ever need to borrow more, said Tom Hendry, senior vice president and treasurer. It might tap the market if normal cash flows were unable to meet an uptick in surrenders—policy cancellations that trigger a cash payout—or policyholder loans, and its high rating allows it to borrow at favorable rates compared with other companies.

“During the Silicon Valley Bank crisis, there was some tightening in the market,” said Mr. Hendry. “Rates ticked up, but we didn’t feel like we were getting squeezed.”

The banking-sector disruptions put pressure on borrowing rates for Corp. , one of the largest power producers in the U.S.

“Some companies weren’t able to get the funding or the term they needed from commercial-paper issuances and needed to borrow from their credit facilities,” said Karl Newlin, Duke Energy’s senior vice president of corporate development and treasurer. “We were able to access the commercial paper markets, but at higher rates.”

Barring further banking issues, Mr. Newlin doesn’t anticipate any hurdles going forward.

Lenders were spooked into keeping their cash in shorter-term or safer assets. Further crimping their willingness to lend, investors were yanking cash from prime funds in favor of their government counterparts, which stick to Treasurys, repos and similarly safer assets.

The quick flinch in commercial-paper markets echoed March 2020, when the market seized up and required intervention from the Fed. Minutes from the Fed’s meeting in March showed that staff discussed the pressures in the CP/CD market. 

Encouragingly, volumes have since recovered above their long-term averages, leading some analysts to play down the episode’s severity.

“This comes nowhere close to what we saw in 2020,” said Nafis Smith, head of Vanguard’s taxable money markets group.

Still, regulatory scrutiny that cropped up regarding prime funds in the aftermath of the 2008 financial crisis persists

Illustration: Preston Jessee

“If there is any place where the vulnerabilities of the system to runs and fire sales have been clear-cut, it is money-market funds,” said Treasury Secretary Janet Yellen at an economics conference on March 30.

That risk of a wave of withdrawals from money funds cascading into broader financial stability hasn’t been sufficiently addressed, she said. Vanguard’s Mr. Smith said the issues highlighted by Ms. Yellen primarily apply to prime funds. Government funds, which have a stricter set of investment options, carry “similar risk profiles to a bank deposit,” he said.

Assets in prime funds fell dramatically after 2016. Regulations were enacted, aimed at preventing funding lockups similar to when concern over Lehman Brothers’ paper sparked a run on the $62 billion Reserve Primary Fund. That caused its net asset value to drop below $1 a share—known as breaking the buck. A wave of withdrawals on other money funds followed, forcing a government response.  

Forthcoming regulatory changes threaten to shrink the prime fund industry further, likely raising funding costs, analysts said.

Money-market funds sit at the fulcrum of the financial system, providing credit to banks and other companies while helping investors manage their cash. Assets in money funds have surged more than $715 billion to a record $5.28 trillion since the Fed began raising rates, Investment Company Institute data show.

“Whether we are through this mini-banking crisis or not, we need a little more time and space to see that play out,” said New York Life’s Mr. Hendry.

Write to Eric Wallerstein at [email protected]

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