Relationship pundits say an indispensable element to any successful connection is communication. In the world of structured finance, where the stakes are higher, a solid liquidity backstop is emerging as the key to a successful relationship between CDOs and the asset-backed commercial paper conduits that fund them.
True enough, a reliable liquidity facility must be in place for any ABCP to sustain attractive returns over time. The need is more pressing these days, as risk-based capital standards under Basel II implementation looms in Europe and is still being hashed out in the U.S. As such, banks and conduit managers alike are on the hunt for the best ideas in designing reliable liquidity schemes, especially for programs that fund CDOs.
Certain mortgage warehouse conduits resemble certain CDOs, in that those vehicles have swaps, or put providers, which will take out all of the performing loans if the vehicle winds down. There are limitations, however, because the put providers will not take out the nonperforming underlying loans, said Joseph Johnson, a vice president at Goldman Sachs, at the recent American Securitization Forum conference.
Traditional bank liquidity facilities becoming increasingly expensive, besides which they sometimes involve hard negotiations before suitable agreements can be put into place.
"Under [the] old agreements with banks, we would have to renew the liquidity facilities every year," said Sonia Mangelsdorf, a senior vice president at Trust Company of the West, who runs its CDO product development group, who also spoke at the ASF conference. "We had to go to the banks and pull teeth to get the banks to sign up, and they would charge us more for the facilities."
When the asset manager does cashflow deals, it prefers to have a put, because they know at which level CP will get taken out.
TCW prefers that because there is an ultimate limit on the put agreement. Therefore, they are always aware of what the worst-case scenario would likely be, Mangelsdorf said.
Times are rapidly changing, so that program sponsors and managers can devise vehicles which utilize the internal liquidity provided by underlying assets or market value schemes, which offer a vehicle liquidity support with little or no external support. These are quickly becoming more of a mainstream fixture in the ABCP sector, even if they account for a small portion of the overall liquidity backstop market.
The market is also seeing more funding of CDO-like programs - whether directly or indirectly - through extendible notes in ABCP conduits.
"More and more investment managers are looking to use ABCP to fund another type of arbitrage portfolio, which is similar to a CDO," Everett Rutan, who runs the ABCP group at Moody's Investors Service, said in an interview. The ABCP program funds the same type of assets that would go into a CDO.
Managers who prefer to go the distance in the term market use the ABCP programs as a means of warehousing assets that will eventually collateralize a CDO.
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