By SAM MAMUDI
One consequence of the financial crisis is that U.S. money-market funds have been buying more European bank debt.
The combination of U.S. banks issuing less debt and funds looking to diversify has seen European banks play a dominant role in U.S. money-market-fund portfolios. Even European debt fears haven't stemmed the appetite.
The percentage of foreign-bank obligations—which largely are European and include Eurodollar certificates of deposit, Yankee dollar CDs and bankers' acceptances—in prime money-market funds rose to 11.5% as of July from 9.8% a year earlier and 7.9% in July 2008, according to research firm iMoneyNet.
The move into European paper may alarm some investors concerned about the debt situation in the euro zone.
.The research firm doesn't break out time deposits, such as fixed-term savings accounts and certificates of deposit, by geography. But one study at a Wall Street firm estimated that most of those holdings are from European banks, and suggests that European deposits are the single-biggest part of money-market funds' holdings.
Debbie Cunningham, head of money-markets funds at Federated Investors, said the financial crisis pushed funds overseas in two ways: The shock of Bear Stearns and Lehman Brothers Holdings going bust meant that fund managers saw greater imperative to diversify more to international holdings, while the recession—and disappearing banks—has shrunk the domestic commercial-paper-supply market as growth has stalled.
Ms. Cunningham said she has seen an increase in the use of foreign debt in Federated's funds, adding the firm typically buys paper from "very large global companies" such as Spain's Banco Santander, Germany's Deutsche Bank and U.K. bank Barclays.
A study by Capital Advisors Group also found an increase in foreign exposure, especially to European debt. The study said 44% of a typical U.S. prime money-market fund is in non-U.S. financial debt, a figure that jumps to 69% for larger prime funds.
The percentage of foreign issuers in the U.S. commercial-paper market rose from about 21% in July 2007 to about 40% in April, the latest available figures. In the financial commercial-paper market, the percentage of foreign issuers rose to 77% in April from 59% three years ago.
The move into European paper may alarm some investors concerned about the debt situation in the euro zone and the U.K. But funds have avoided problems.
Lance Pan, director of investment research and author of the Capital Advisors study, said one shift he has noticed as a result of the European sovereign-debt crisis is that funds have been buying paper of shorter duration and investing less in smaller banks.
"They used to buy [debt from] second- or third-tier banks, but now [most] exposure is to megabanks," he said.
The Wall Street firm's study noted that at the peak of concerns about European sovereign debt, money funds lowered their exposure to the Continent's banks, but that from May the trend has been to re-enter the market, with holdings now close to peak levels.
Ms. Cunningham said Federated's funds have responded to market conditions not by abandoning Europe, but by shortening the duration of their holdings.
"While we may still be using Barclays or Deutsche Bank, it's not for one-year exposure, it's more like six months," she said. "And if we were holding six-month paper, that's now three months."
Connie Bugbee, managing editor at iMoneyNet, said the move into more European—and foreign—debt is a trend that is likely to stick. While some prime money funds are barred by their prospectuses from buying overseas debt, she said, those that are able will continue to do so even once the U.S. economic picture improves.
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