Analysis: Junk rating makes MF Global's funding pressures worse

NEW YORK (Reuters) - The downgrade of futures brokerage MF Global Holdings Ltd's debt to junk has made it tougher to raise money to fund day-to-day operations, market sources said.

MF Global, headed by former Goldman Sachs chief Jon Corzine, needs to raise sufficient cash daily in the open market to cover its trades and operations, or else it would have a hard time staying afloat.

This week the firm was downgraded to junk status by Moody's Investors Service and Fitch Ratings, making other financial institutions more skittish about lending to MF Global.

When a broker's credit rating drops to junk, it erodes confidence in its creditworthiness and can then restrict its ability to borrow - the bedrock of any financial institution.

Its troubles become "a self-fulfilling prophecy," said Perry Piazza, director of investment strategies at Contango Capital Advisors in San Francisco. "The end game here is not good," he said.

It can still raise cash right now, albeit at a reduced capacity, according to market participants.

MF Global did not respond to requests for comment.

The outlook for the MF Global has rapidly deteriorated on concern about losses it may suffer from heavy bets on debt from troubled European countries including Italy, Spain and Portugal. European leaders this week came up with a deal to contain the problems, but success in stemming the euro zone's debt crisis is uncertain.

The firm's position in the repurchase market -- a vital place for short-term funding -- is under intense scrutiny because of the weakness in European debt, the sources said.

Shares in MF Global lost more than two-thirds of their value this week and closed at $1.20 on Friday. The company's bonds hit a low of 38 cents on the dollar, later rebounding to the mid-40s, but still implying a high likelihood of default.

MF Global's bank loans were lower Friday after reports from Reuters and others that it had drawn on its revolving credit lines. The extended revolver due 2014 is quoted 60-65 on Friday after a large piece of the paper is said to have changed hands on Thursday at 70, sources said.

The rating downgrades may raise some collateral costs on its outstanding derivative positions, based on the content of company filings earlier this year.

TEMPTING RISK

Since May, U.S. money market funds and other investors have slashed their exposure to Europe. But MF has retained a large investment in European sovereign debt relative to its size.

As of September 30, MF Global had a $6.3 billion exposure in short-term European sovereign securities.

MF's European sovereign exposure was mostly funded using repurchase agreements or repos, generally seen as low risk.

The company has $17.1 billion in outstanding repo agreements as of September 30, according to its earnings statement on Tuesday. Repurchase agreements are short-term loans that are used by financial institutions to fund ongoing operations.

The firm pledges securities as collateral in exchange for loans maturing from overnight to a year.

MF has long-term agreements in which European government debt securities are collateral. Because that collateral is perceived to be of lower quality, it makes MF a riskier borrower itself in the repo market.

This in turn makes lenders less likely to do business or charge them more than less risky firms, increasing funding pressure.

Moody's rates MF Global at Ba2, two levels below investment grade, and it has the company on review for further downgrade. Fitch has it at BB-plus, one level below junk, and on review for another downgrade. S&P has the firm on review for downgrade to junk -- currently its rating is at BBB-minus, the lowest investment grade.

(Reporting by Richard Leong and Karen Brettell)