NEW YORK (S&P Global Ratings) July 22, 2022--As the Fed pursues rate tightening, S&P Global Ratings expects certain funds with longer-dated positions and longer average maturities to experience modest stress on their net asset values (NAVs). Since January 2022, the Federal Reserve has increased its target federal funds rate from a lower bound of 0.00%-0.25% to 1.50%-1.75% as of June 2022. S&P Global Economists now expect the Fed to be much more aggressive, with the policy rate rising from zero at the beginning of 2022 to 3% by year-end, reaching 3.50%-3.75% by mid-2023 (see "Global Economic Outlook Q3 2022: Rates Shock Puts The Economy On A Slower Path," published June 29, 2022). We expect the Fed to keep monetary policy tight until inflation decelerates and nears its target in the second quarter of 2024. From our recent observations, it appears the market is preparing for an interest rate rise of 75 basis points next week, with some possibility of an increase of 100 basis points.
When assigning a principal stability fund rating (PSFR), we assess management's focus on key characteristics such as credit quality, diversification, maturity, and liquidity of assets as tools to determine the likelihood of a fund maintaining a stable NAV (see "Principal Stability Fund Rating Methodology," June 23, 2016). These characteristics reflect management's approach and commitment to maintaining principal stability. While this task is generally challenging during times of market volatility, for principal stability funds, management may be placed under enhanced pressure during periods such as the one we are experiencing now: rapid inflation risk accompanied by uncertain and large magnitude monetary policy action to manage that risk. Typically, but not always, managers reposition portfolios to limit risk of volatile NAVs by shortening duration and managing liquidity risk with enhanced focus on stress scenarios.
If a 'AAAm' rated fund's NAV falls below 0.9985, we typically enhance our standard surveillance to ensure funds are maintaining metrics consistent with their assigned rating (i.e., for a 'AAAm' rated fund, the lowest NAV threshold to maintain that rating is 0.99750 [see table]). More specifically, our enhanced surveillance includes a shift from weekly portfolio pricing submissions to daily portfolio pricing and stress testing. Enhanced surveillance may also include daily dialogue with the rated fund sponsors. If we observe continued NAV deterioration based on our daily review, we often request a formal management action plan (MAP), typically when marked-to-market NAVs are at or below 0.9980.
We focus on these NAV levels as warning signs that a fund is inching toward a NAV of less than 0.9950, at which point the fund will have "broken the buck" as its NAV falls below $1. We focus on these levels to better understand management's commitment to and plan for limiting NAV volatility. We state different NAV sensitivities in our rating criteria in part to provide clarity to the market and fund managers that we would prefer to transition ratings through categories as opposed to simply waiting for a fund to break the buck--which would represent a rating of 'Dm'.
As such, if NAVs fall below 0.9975 for a 'AAAm' rated fund, we have a maximum five-business-day cure period for management to restore and maintain the NAV to at least 0.9975, which is the lowest NAV associated with 'AAAm' rated funds. During the cure period, we would take into account a fund sponsor's MAP to remedy the pressured NAVs as we consider whether to place a rating on CreditWatch or not. We may also provide a bulletin to the market identifying those specific funds whose NAVs are below our criteria's threshold to support their rating (e.g., 0.9975 for 'AAAm' rated funds). A failure to cure the NAV breach within those five business days would typically lead to a downgrade.
So far, in the current inflationary cycle, we have not taken any rating actions on funds rated under the PSFR methodology. We continue to closely monitor developments under an enhanced, often daily, surveillance.
| Maximum NAV Movement Per PSFR Category | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| AAAm | AAm | Am | BBBm | BBm | Dm | |||||||||
| NAV ranges* | -0.25% or 0.9975 | -0.30% or 0.9970 | -0.35% or 0.9965 | -0.40% or 0.9960 | -0.5% or 0.9950 | >0.50% or less than 0.9950 | ||||||||
| *For all funds (regardless of rating), failure to increase the frequency to daily (from weekly) for portfolio pricing, marked-to-market NAV calculations, and stress testing when the NAV goes beyond -0.15% deviation (i.e., falls below 0.9985) result in a review of the sufficiency of management’s pricing policies and NAV deviation policies and could result in a lower PSFR. | ||||||||||||||
This report does not constitute a rating action.
S&P Global Ratings, part of S&P Global Inc. (NYSE: SPGI), is the world's leading provider of independent credit risk research. We publish more than a million credit ratings on debt issued by sovereign, municipal, corporate and financial sector entities. With over 1,400 credit analysts in 26 countries, and more than 150 years' experience of assessing credit risk, we offer a unique combination of global coverage and local insight. Our research and opinions about relative credit risk provide market participants with information that helps to support the growth of transparent, liquid debt markets worldwide.
| Primary Credit Analysts: | Joseph Zimbalist, New York +1 8045231867; joseph.zimbalist@spglobal.com |
| Michael Masih, New York + 1 (212) 438 1642; michael.masih@spglobal.com | |
| Secondary Contacts: | Guyna G Johnson, New York + 1 (312) 233 7008; guyna.johnson@spglobal.com |
| Andrew Paranthoiene, London + 44 20 7176 8416; andrew.paranthoiene@spglobal.com |
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