Once a popular source of funding for bank lenders, loan-backed commercial paper conduits have quickly become the dinosaurs of the ABCP market, and should be nearly wiped out by year-end, sources said.
In September, Mellon Bank's $700 million Sweetwater Capital Corp. is scheduled to terminate, at which point the CP investors will be paid out, either through loans maturing or being bought out of the conduit by the sponsor. Following Sweetwater, Centric Capital Corp., a $2 billion loan-backed facility of Wachovia Corp., is set to wind down. Several other programs have already been closed this year, including Deutsche Bank's Citation Capital Inc. and Credit Lyonnais' Lyon Short Term Funding Corp.
As often is the case with securitization, more efficient structures have rendered their predecessors obsolete. In this instance, loan-backed conduits must compete with structures such as collateralized loan obligations (CLOs) - both cash and synthetic - as management tools for bank loan portfolios.
"No [bank] sponsor has come to us to set up one of these [loan-backed] vehicles in the last two or three years," said Sam Pilcer, head of the ABCP group at Moody's Investors Service. "When we talk to sponsors, we're typically talking about more efficient ways to deal with capital relief for bank loan exposure, such as synthetic vehicles, which provide credit relief through the use of synthetics and credit-linked notes."
Banks were generally using loan-backed conduits to remove unsecured loans from their balance sheets, funding them in the commercial paper market. Over the past several years, banks have increasingly used CLOs, which tranche out and fund the portfolio in the term market. Synthetic CLOs have also been increasingly used to manage loan portfolios, often as a way to score regulatory capital relief. The structures allow banks to transfer the risk associated with a portfolio, without actually selling the underlying loans.
One of the major downsides of the loan-backed conduits is that they require a relatively high level of credit enhancement from the sponsor, which translates into higher risk-based capital requirements. Credit enhancement is basically treated like a loan by the regulators. According to Moody's, loans to non-investment grade borrowers require 100% credit enhancement when placed in the conduits.
Also, conduit-funded loans were generally structured as short term - sometimes in the 90-day range - to match funding with the CP market. Typically, these loans were extended on a continuing basis. Since most cash CLOs are backed by term loans, lending agreements written for the conduits will likely be restructured to be more conducive to CLOs, or other balance-sheet management vehicles, Moody's Pilcer said.
Moody's also notes that the loan-backed conduit would be a target for consolidation under the anticipated changes in guidelines from the Financial Accounting Standards Board (FASB). Basically, it would be difficult to argue the bank sponsor was not the primary beneficiary.
Volume steadily declining
Meanwhile, the ABCP market posted its fourth consecutive month of declining volume in July, inching down to $700 billion, a $13 billion drop from June's numbers. Notably, ABCP as a percentage of the entire commercial paper market declined slightly in July, though asset-backed paper still represents more than 52% of total CP. On a year-over-year basis, outstanding ABCP is up just $36 billion from last July. The entire CP market, however, is down more than $110 billion year-over-year.
The ABCP market peaked in December 2001, when outstandings hit $745 billion. With balance sheet cleansing in full gear, December is typically a heavy month, averaging a $30 billion increase in outstandings for each of the last three years.
ABCP first passed the 50% mark in November of 2001, and has, for the most part, been steadily increasing its market share throughout the year, despite the steady decline in volume since January.
A popular scapegoat for the sinking volume has been FASB and the accounting uncertainties associated with the consolidation project, which is said to have put deals on hold. Other market professionals, however, have argued that the slowing economy, and subsequent lower demand for working capital financing, has had a larger impact.
According to Moody's Pilcer, another culprit is that the bank appetite for credit exposure has been decreasing, with Wall Street tightening up. "We've heard that they are having a much tougher time getting deals credit approved," Pilcer said.
Meanwhile, the research group at JPMorgan Securities last week noted that securities arbitrage conduits are becoming an increasingly large investor base in the triple-A tranches of CDOs (see p.3). The bank estimates that CDO-backed ABCP accounts for as much as $60 billion of the market.