Fitch Ratings published a brief entitled, "U.S. Prime MMF Credit Exposure Manageable, But Risks Loom." They write, "U.S. prime money market funds (MMFs) have limited exposure to issuers in the energy, travel and automobile sectors, which are among the sectors most directly impacted by the coronavirus pandemic. [A table] shows 21 selected nonfinancial corporate issuers, totaling $1.1 billion in prime MMF holdings as of March-end, representing only 2.4% of the funds' total assets. Fitch Ratings' most recent rating actions on most of these issuers primarily involved changing their Rating Outlooks to Negative; most short-term ratings remain at least 'F1' with some 'F2' exposure already sold or matured."
Fitch explains, "While exposures are low on average, certain funds have higher allocations to these issuers, likely reflecting individual managers' confidence in the issuers' credit quality, low investor sensitivity to associated headline risk, and/or a search for yield. For example, as of March-end, the Principal Money Market Fund (not rated by Fitch) had 10% of assets invested in eight of these issuers. Indeed, exposures to a few of these issuers increased in March, including to those in the oil sector (which has been under severe stress), although issuers in MMF portfolios maintain high ratings."
The brief continues, "Prime MMFs' exposure to financials is significantly higher than to corporates.... Fitch took various negative rating actions in the sector due to the effects of the coronavirus outbreak. The impact to MMFs has been limited here as well, as the majority of the rating actions consisted of affirming long-term ratings and changing Rating Outlooks to Negative or placing the ratings on Rating Watch Negative (RWN). A few ratings were downgraded, such as the long-term and short-term ratings of certain Australian banks and their New Zealand based subsidiaries. However, they remain highly rated and thus eligible for inclusion among 'AAAmmf' rated funds."
It states, "While Fitch's base case coronavirus assumptions include a recovery beginning from 3Q20 onward, a meaningful recovery is delayed until after 2021 under the agency's downside scenario, which would have more pronounced rating implications for financial institutions and, by extension, prime MMFs."
The brief also tells us, "MMF managers have been reducing risk exposures in portfolios, focusing on shorter dated maturities and/or higher quality issuers to mitigate liquidity and credit risk. Given the high levels of redemptions prime MMFs experienced in March, the funds sold certain securities to meet redemptions, although it is not clear from available data if fund managers sold any of these holdings due to credit concerns as well."
Finally, it adds, "MMFs would likely be downgraded from 'AAAmmf' if elevated PCFs or unsecured 'F2' exposures become material and are not resolved in the short term. The determination of materiality is a function of the level of PCFs [portfolio credit factors] or size of 'F2' exposure, expected length of the breach and the drivers of the breach. Under Fitch's criteria, MMFs rated 'AAAmmf' cannot have exposures rated below 'F1', excluding certain overcollateralized repossession exposures. Fitch-rated prime MMFs do not currently hold any unsecured exposures rated below 'F1'. Fitch maintains a Negative Outlook on the prime MMF sector given continued market volatility and the potential for additional credit issues to affect MMFs."
The ratings agency also published the release, "Fitch Ratings Updates Money Market Fund Rating Criteria" which tells us, "Fitch Ratings has published an updated version of its 'Money Market Fund Rating Criteria'.' These criteria update Fitch's criteria of the same title published on 6 May 2019. This criteria report primarily focuses on the key rating considerations when assessing the capacity of an MMF, or of other liquidity- or cash-management products, to preserve principal and provide liquidity through limiting credit, market and liquidity risk."
It continues, "The emphasis is on a manager's ability to avoid losses through limiting credit, market and liquidity risk rather than the particular accounting convention used to calculate NAV, and therefore the criteria are applicable to constant net asset value (NAV), variable or floating NAV, and European low-volatility NAV funds. The criteria are also applicable to other liquidity- or cash-management products such as separately managed accounts, private funds, or other similar vehicles that have comparable investment objectives and operating frameworks to MMFs.... The key elements of Fitch's 'Money Market Fund Rating Criteria' are unchanged, and Fitch therefore does not expect any related rating changes."
The full updated "Money Market Fund Rating Criteria explains, "These rating criteria are principles-based, focusing on an MMF's overall risk profile and its key risks -- credit, liquidity and market risk. The thresholds outlined in the report for these risks can be adjusted for qualitative considerations, such as the manager's resources and track record and the investor base profile, among others."
It says, "Fitch analyses credit risk from two perspectives. First, Fitch seeks to understand the manager's credit-selection capabilities and ability to avoid credit events and limit credit-driven losses. Second, Fitch analyses the portfolio's key credit attributes including the short-term ratings assigned to portfolio investments, unsecured versus secured exposures, the level of diversification, and counterparty risk. Fitch's analysis of liquidity risk assumes reduced or absent secondary market liquidity for most securities, save certain ultra-high quality (government and agency) securities.... Fitch also considers the stability and predictability of the investor base and views an intrinsically stable or captive investor base a critical countervailing factor in its assessment of a fund's liquidity needs."
Fitch writes, "Providing investors with timely liquidity is a core MMF objective. MMFs therefore need to be able to meet potentially large, sudden investor outflows, including at times of market stress when secondary market liquidity may be reduced or absent. Fitch's assessment of liquidity risk considers both the liquidity profile of the portfolio of assets, as well as the predictability and stability of the investor base, particularly in times of market stress."
Lastly, they comment, "Funds may adjust liquidity levels up or down to account for specific considerations relating to a fund's investor base, the overall level of concentration and redemption risk, the results of any liquidity stress testing undertaken by the fund manager, or any other backup liquidity arrangements. For example, a fund with a concentrated investor base or an over-reliance on less stable fund flows may need an additional liquidity cushion, whereas a fund with a diversified, intrinsically stable, or captive investor base may be able to operate with lower levels of liquidity."
