ABCP got its share of attention last week as Fitch Ratings, Goldman Sachs and Standard & Poor's all held ABCP conferences in New York in what was dubbed "CP Week" by some. The conferences highlighted a variety of issues affecting the sector, but arguably the most salient topic was compliance with the eligible liquidity facility rule that becomes effective Sept. 30.
The rule sets up the classification of eligible liquidity facility and states that qualifying banks will have to carry less regulatory capital than those that do not qualify as eligible liquidity facilities. The rule was published jointly by the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the FDIC and the Office of Thrift Supervision to smooth the way for similar requirements in the yet-unfinished Basel II international banking rules.
Eligible liquidity facilities falling under the U.S. standard will benefit from a 10% credit conversion factor, while entities other than eligible liquidity facilities will be subject to a 100% credit conversion factor. Those with the 100% credit conversion factor face capital treatment for liquidity facilities that would be the same as for credit facilities and other balance sheet exposures.
The rule also establishes that banks funding ABCP conduits must not fund any assets past 90 days delinquent or any that are below investment grade, if they are to be considered eligible liquidity facilities. That means banks are likely to stop funding such assets in order to keep their eligible liquidity status, and the risk will be passed to investors. "The amount of risk in a conduit is not changing, what is changing is who is bearing that risk," said Deborah Seife with Fitch.
It is likely that liquidity providers will have to add increased credit enhancement to their deals to compensate investors for that risk. Fitch has developed a rating adjustment table that can be used to calculate the program-wide credit enhancement necessary on deals as assets migrate lower on the ratings scale. The table is based on equating the empirical migration rate for each rating category to Fitch's default probability curve.
S&P expects credit enhancement to cover the additional risk to investors for liquidity banks not funding below investment grade securities "to be no worse than the ratings transition experience for structured finance securities over various exposure periods depending on the tenor limitations of the ABCP issued." S&P plans to release its ratings criteria for the impact on credit enhancement as related to the rule after additional research and feedback from market participants has been gathered.
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