Friday's "Short-Term Fixed Income" update from J.P. Morgan Securities discusses Moody's bank ratings reviews and pending downgrades, and their impact on money market fund portfolio holdings, among other things. The piece says, "Since mid-February, when Moody's first announced its review of both Global Capital Market's Institutions (GCMIs) and global banks, the credit markets have not-so eagerly anticipated the results. Following a short delay -- understandable given the scale of its task -- Moody's has been adjusting ratings lower, generally following the order it previously announced. This past week, the agency adjusted its ratings on Austrian and German banks, and the GCMIs are now next on the list. For the GCMIs, the moment is here."
JP Morgan's weekly writes, "We have previously noted that even if all the GCMIs' ratings are cut to the lowest level originally suggested by Moody's, it should not trigger a funding crisis in short term debt because both issuers and investors have had months to prepare. Later in this note, we present data on the degree to which MMFs have prepared. It is also worth noting that some of the investors most sensitive to Moody's ratings -- the Moody's rated MMFs -- have some latitude under fund rating guidelines to continue to hold downgraded debt, even bank debt downgraded to P-2. So, fund guidelines should not precipitate liquidations upon a Moody's downgrade."
It explains, "As of this writing, Moody's has yet to conclude its ratings review of GCMIs and to many money market participants, this is the main event as these institutions are often the largest borrowers in the money markets, particularly through the repo market. According to our estimates using MMF holdings data (including government MMFs), GCMI counterparties represented about $510bn or 89% of total repo held by MMFs."
The piece continues, "Our initial May month-end estimates reveal that MMFs significantly reduced exposures month-over-month to "other repo", which consist of repo collateralized by nongovernment securities, shifting exposures to repo collateralized by treasuries, agency debt, and agency MBS. This shift was likely driven mostly by funds that carry fund ratings from Moody's. From a Moody's fund ratings perspective, "other repo" would fall under non-traditional repo which count as exposure to the counterparty, whereas overnight repo collateralized by Aaa-rated government or government-related securities receive look-through treatment. As the ratings conclusions became more imminent, MMFs rolled their nongovernment repo to government repo, much of which are overnight in maturity."
JP Morgan adds, "We also remind our readers that from a money fund ratings perspective, for entities not rated by Moody's, the agency looks to the parents' ratings (many who are also facing downgrades) of the unrated entities to assess ultimate credit quality. This applies to many primary dealers that are not rated by Moody's but have parents who are rated. This may sound very onerous for Moody's rated funds but Moody's fund ratings criteria, in some ways, are less restrictive than those of S&P and Fitch."
Finally, the weekly tell us, "Moody's matrix approach considers the maturities of the securities along with their credit quality, which allows a bit more flexibility in managing the overall credit quality of the portfolio than S&P or Fitch's fund ratings methodologies, which bar the holding of any Tier-2 (A-2/F2) rated security. Even with potential downgrades of active repo counterparties looming, we don't expect MMFs in aggregate to trim repo exposures significantly in the coming weeks. With repo levels still elevated, which we expect will continue to be the case at least until the end of Operation Twist, and levels cheap versus repo substitutes like T-bills and agency discos, we expect demand for repo to remain fairly stable in the near term."
