Risk appetite in the U.S. triparty repo market is slowly returning, according to Fitch Ratings in a report released today.
This is shown by the rise in riskier forms of repo collateral as well as a drop in haircuts, the rating agency reported.
Fitch based its findings on repo deal data from a sample of the 10 biggest U.S. prime money market funds (MMFs). This comprises roughly $90 billion in repo offerings as at the end August 2011.
"Repos remain an important component of the financial (or 'shadow' banking) system, with lenders providing credit by investing cash while borrowers use this funding market as source of leverage," the report stated.
The rating agency found that structured finance has been the mostly the driver of the increased existence of riskier repo collateral types. Structured finance makes up 20% of all repo collateral in the rating agency's sample, with roughly half of this in Alt-A and subprime RMBS and CDOs.
According to Fitch, the median ratio of this collateral's value to the principal amount is 43%, which serves as a proxy for the securities' discounted pricing.
Repo haircuts, after peaking in a crisis and its aftermath, have recently receded, Fitch stated. This is a potential sign of a thaw in credit conditions. For inctance, median haircuts on repos backed by structured finance collateral dipped from 8% to 5% at the end of August, the report indicated. The median haircuts for both equity and corporate debt collateral have also dropped from recent highs.
Fitch added that the disruptions in the repo market can cause potential risks for financial institutions, which might experience funding challenges considering the risk aversion of MMFs as repo lenders. For MMFs, deals that are backed by less liquid securities are vulnerable to market distress, with valuation dips undermining the collateralization for the repo's remaining term.
Fitch added that repo market disruptions can also potentially impair the liquidity and valuation of assets that lose acceptance as collateral. This impacts, according to Fitch, repo market players as well as cash buyers that are taking long positions and not deploying leverage.
