Abridged from Moody's Third Quarter Asset-Backed Commercial Paper Market Review, by Annika Sandback, vice president and senior analyst.
Average daily ABCP outstandings for the second quarter of 1999 rose to a new high of $432 billion. Although this figure represents a relatively sluggish quarterly growth rate of 6%, historically the second quarter tends to be the slowest-growing quarter in the ABCP market. For example, the growth rates in outstandings in the second quarters of 1998, 1997, and 1996 were 5.4%, 6.7%, and 6.8%, respectively.
However, on an annual basis, outstandings increased by 52.1%, from $284 billion in the second quarter of 1998 to $432 billion in the second quarter of 1999. This figure compares with a growth rate of 51.3% for the four quarters up to and including the first quarter of 1999.
Changes In The Abcp Market's Program And Asset Mix
While the ABCP market continues to boom, the complexion of the market - both in terms of program type and asset type - is also changing at an unprecedented pace, with some dramatic changes occurring over the past 18 months.
Changing Program Mix: Securities Arbitrage
Programs Of New
The largest change in the ABCP market's program mix over the past 18 months has been in the securities arbitrage segment. Although in terms of outstanding ABCP securities arbitrage programs increased only four percentage points - from 9% of the market in September 1997 to 13% in June 1999 - this is the fastest growing segment of the market. What the statistics mask is the acceleration in the number of new programs established in 1998, which has reached a fever pitch in 1999.
Citibank pioneered the securities arbitrage segment of the market, establishing Alpha Finance Corporation Limited in 1988 and Beta Finance Corporation & Beta Finance Corporation Limited in 1989. The next new securities arbitrage program was established in 1993, followed by three in 1994, and five in each of 1995, 1996, and 1997. Growth took off in 1998, when 12 programs were established, and continued with the establishment of 10 programs in the first two quarters of 1999.
As the newer securities arbitrage programs begin to issue paper, Moody's expects this segment of the ABCP market to become a much larger percentage of the total, in terms of outstandings.
Fully Supported, Multiseller Programs,
The second significant change in the ABCP market's program mix occurred in the fully supported, multiseller segment, whose share has decreased over the past 18 months fairly dramatically, from 19% to 12% of the total.
One cause of this decline is the continued efforts of ABCP program sponsors to cut costs. The reason for this is simple: Most program sponsors continue to provide the majority of liquidity and credit enhancement for their programs. Therefore, a program which receives full support from a liquidity facility provided by the sponsor bank typically attracts an 8% capital charge for the bank against the full amount of the liquidity facility. This charge renders it uneconomical for most banks to fund a large amount of assets through a fully supported program.
Those programs that receive full support from a structured liquidity facility and do not attract a capital charge for the provider of that support facility may raise another concern for the program sponsors: Potential regulatory changes could require capital to be held against these facilities.
Changing Asset Mix
There have also been some big changes in the types of assets funded by ABCP programs in the past 18 months: a dramatic growth in collateralized loan obligations (CLOs) and collateralized bond obligations (CBOs), and a sharp drop in trade receivables.
CLOs/CBOs: Many Financed By ABCP Programs
CLOs and CBOs, collectively referred to as collateralized debt obligations (CDOs), are the hottest asset type in the ABCP market today. For example, for the top 20 partially supported multiseller programs, the CDO segment increased from 2% of outstanding ABCP in September 1997 to 12% in June 1999. As with the figure for the securities arbitrage segment's share of the market program mix, this 12% figure is grossly understated. There are a few reasons for this: The figure represents only those CDOs that are funded by the 20 largest partially supported, multiseller programs when, in fact, almost all ABCP programs own CDOs, including many securities arbitrage programs. In addition, some programs that do not fit into the partially supported, multiseller segment of the market have been established specifically to purchase CDOs.
The primary driver behind the financing of so much of the CDO market via ABCP is that the spread between what a conduit can receive on a CDO and the conduit's cost of funds has been relatively wide. In fact, because the cost of funding CDOs in the ABCP market is so much less than it is in the term ABS market, some issuers of large bank balance sheet CLOs have chosen to fund them through their own conduits. Examples include CIBC's own $4.6 billion CLO funded through its SPARC conduit, and Bank of Nova Scotia's own $2.4 billion CLO funded through its conduit, Liberty Street.
The growing presence of CDOs in the ABCP market is just keeping pace with the continued growth of the CDO market in general, which has continued at an incredible rate in the second quarter of 1999. Growth for the full year of 1999 looks even more vigorous.
Moody's expects ABCP program sponsors to continue to invest in CDOs as the CDO market continues to grow.
Trade Receivables: No Longer The Mainstay Asset
Trade receivables dropped a full eight percentage points, from 27% in September 1997 to 19% in June 1999, of the assets funded by the 20 largest partially supported, multiseller programs. This decline is the continuation of a trend that began in the mid-1990s.
The original ABCP conduits - such as Citibank's CAFCO and Ciesco, Bank One's PREFCO, and Falcon and CIBC's ASCC - were established in the late 1980s and early 1990s primarily to fund trade receivables. But there has been a steady increase in the number and size of new asset types funded by the conduits, pushing trade receivables down as a percentage of total business. In 1994, trade receivables represented 54% of outstanding ABCP for the top 20 partially supported, multiseller programs. This figure had dropped by almost two-thirds by June 1999.
While the asset mix has changed in percentage terms as more long-term assets are funded by ABCP programs (some of which, such as credit cards and CDOs, are growing at a much faster rate) one should not conclude that ABCP conduits are not interested in financing trade receivables. The dollar amount of trade receivables financed through the top 20 partially supported, multiseller programs increased from approximately $49 billion in September 1997 to $81 billion in June 1999. Thus, the dollar amount of trade receivables financed through the ABCP market continues to grow, but the segment has been overshadowed by the increase in term assets financed by the market.
The Search For Alternative Sources Of Liquidity
As Moody's has reported over the past year, third-party liquidity support for ABCP programs continues to become increasingly expensive and more difficult to find. In reaction to this shortage, ABCP program sponsors have continued to develop new and creative means of providing liquidity to their conduits. Methods include use of the value of a program's assets in the securities arbitrage programs, the use of insurance companies as providers of liquidity, and increased popularity of the club deal.
Methods which Moody's is seeing more interest in lately include liquidity notes (sometimes referred to as extendable commercial notes, or ECNs), medium term notes, and liquidity facilities provided, on a joint and several basis, by two Prime-2-rated banks. One of the more innovative of these methods is the issuance of liquid notes.
Bank One, NA1 recently closed a unique program, Lake Front Funding Company LLC, designed to issue an instrument called "liquidity notes." These notes will provide liquidity support to Bank One's two largest ABCP programs, PREFCO and Falcon.
Lake Front is similar in concept to Citibank's Dakota program and to MBNA's "Emerald" certificates programs. In both programs, liquidity is essentially provided by harnessing the intrinsic liquidity of the assets. Lake Front's liquidity notes are similar to ABCP, but if they cannot be rolled on their maturity dates, they are extended to have a legal final maturity of 390 days with monthly interest payments.
In essence, Lake Front will enter into liquidity facilities with PREFCO and Falcon to purchase specific pools of assets and will then issue liquidity notes in the amount of its liquidity commitment. Lake Front will then invest the proceeds primarily in PREFCO and Falcon ABCP.
If Lake Front is called upon to provide liquidity, it will exchange the PREFCO or Falcon ABCP for the assets. Lake Front's liquidity notes will be repaid from the expected cash flows of the PREFCO and Falcon assets received by Lake Front in exchange for the PREFCO or Falcon ABCP. The assets related to the Lake Front liquidity facilities will be highly liquid assets.
Aside from a nominal liquidity revolver and uncommitted swingline facility provided by Bank One, Lake Front does not have any third party liquidity support.
Program Administrators: Changing The Guard
There have been some changes in the list of the top ten ABCP program administrators from the first quarter of 1999. First, the tenth largest administrator changed from Deutsche Bank, which dropped off the list, to Rabobank Nederland, a newcomer to the top ten list, which added a new program in the second quarter, Aquinas Funding LLC, yet another securities arbitrage program.
Second, during the second quarter, the ABCP conduit operations of Union Bank of Switzerland were purchased by ING Barings (U.S.).