BMO Nesbitt Burns recently came out with a $200 million asset-backed commercial paper transaction through its newly-established Canadian Master Trust-Series-E. The deal was rated R-1 (high) by Dominion Bond Rating Service Ltd.
This is the first extendible commercial paper program to be done both in Canada's corporate and asset-backed market.
But it is not only a novelty in Canada but in the U.S. as well. It's a product that was started in the U.S. near the end of 1998, but was mainly used by corporate issuers. There's only one or two asset-backed programs in the U.S. issuing extendable CP.
The program was done in response to the lack of liquidity support from the financial institutions.
Rating agencies usually require liquidity support from a financial institution equivalent to 100% of the commercial paper outstanding to cover for a commercial paper market disruption. Previously, when a market disruption occurs, causing the inability of the program to issue commercial paper, the financial institution bought the notes at a specified interest rate.
The new program eliminated the need for liquidity support from the financial institutions because, in effect, it transferred the market disruption risk from the institutions to the investor.
If there is a market disruption and the CP cannot be rolled over, those holding the extendable commercial paper have the maturity date extended from its initial maturity date for up to 185 days.
"It's really taking roll-over risk and rather than it belonging to the financial institution as a liquidity provider, it is now being passed on to the investors," said the source.
Another issue would be the implementation of the BIS proposal where it states that a 20% risk weighting would apply to standard liquidity agreements existing in the market. This would make liquidity more expensive for investors.
"If this proposal is implemented in the form it is in now, the traditional liquidity lines would become much more expensive," said Mark Adams, assistant vice president at DBRS. These expenses are costs of the trust, and the greater the cost of the trust, the lower the yield offered to investors.
Adams said that investors would ultimately face the choice of continuing to demand traditional liquidity lines and face the cost or alternatively opt for extendable CP and reduce the cost.