Panelists at last week's ABCP conference, hosted by the Strategic Research Institute, expect CDOs and other traditionally term ABS vehicles to continue incorporating short-term instruments into their structures, so long as the funding curve remains steep.
"The term market is borrowing technology that has been in the CP market for sometime," said Marilyn Hill, a managing director at Lehman Brothers and moderator at last week's panel on extendable note technology.
Panelists anticipate that more CDOs will incorporate extendable CP notes into their capital structures. This is one way for CDOs to mitigate some of the liquidity requirements of traditional ABCP.
The money-market CP tranches, which issue and roll over asset-backed commercial paper, are being structured with a put option that acts as liquidity support. Should the CDO manager (or CP administrator) fail to roll over new paper, the CDO manager exercises the put option, and liquidates some or all of the assets (at a preset price) to fund the outstanding CP. These CDOs tend to be backed by high-quality structured finance collateral.
CDOs have been able to access the CP market at the Libor plus five area. The manager also pays about a 20 basis point premium for the put option, plus marketing costs, conference panelists said. While spreads have come in for triple-A CDO seniors, with recent deals pricing in the 40 over Libor range, the short-term structures are still popular.
Risks to investors in these notes include the credit of the put provider and the expertise and familiarity of the collateral manager with the CP market, especially if the manager will act as its own CP administrator, panelists said.
Growth in extendables
Extendable notes now make up more than $70 billion of the outstanding ABCP, or just below 10%. Much of the recent activity has been from single-seller mortgage conduits, as the use of extendable notes can rely heavily on the liquidity of the underlying assets. Credit card and dealer floorplan loans have also been included in extendable programs.
There are two types of extendable notes - secured liquidity notes (SLNs) and collateralized callable notes (CCNs), according to a presentation prepared by Credit Suisse First Boston for a recent conference call. Similar to traditional ABCP, SLNs are repaid on maturity through the issuance of additional SLNs. If the paper cannot be rolled over, the SLN will extend and the assets backing it will be sold to repay the notes by final maturity, often involving a derivative, such as a market value swap, or a put option. CCNs are issued with a call date inside of the final maturity date, and will generally repay at the call date through the issuance of additional CCNs. If the conduit does not exercise the call option on the call date, it amortizes the assets backing the notes to repay on final maturity. During these extension periods, for both SLNs and CCNs, the investor's coupon is "stepped up" by 25 basis points.
Investors are compensated for purchasing extendables, though some believe the spread difference is not adequate. According to one panelist, the best trading ABCP names are currently issuing at Libor minus five to seven basis points, while the ability to extend pushes that out just a few points, to Libor minus three to four.
Federated Investment Manage- ment, for example, will not purchase extendables at current levels, and would discourage administrators from structuring conduits that issue both extendables and non-extendables, unless those conduits still provide 100% liquidity support.
Another investor noted that initial program issuances, such as the SLNs from the Countrywide Home Loans conduit Park Granada, might offer a pickup at inaugural issuance, which disappears once more investors become comfortable with the product.
Matthew Grimes from Wells Fargo Asset Management is not particularly comfortable with extendables because of the illiquidity of the notes if they do extend.
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