Without a home on the domestic side, European commercial paper (ECP) investors have increasingly found shelter in the U.S.
The U.S. was able to support the European short-term market throughout the economic crisis because of its deeper and more mature investor base and via the U.S. Federal Reserve's Commercial Paper Funding Facility (CPFF).
"The U.S. market has been bolstered by U.S. government initiatives and you could argue that this is why the market is still there," said Sharad Samy, a partner at Orrick, Herrington & Sutcliffe. "The Euro CP market does not seem to be a viable source of funding at the moment."
Europe has also made moves to improve market liquidity. The Bank of England, for example, supplemented its special liquidity scheme with a 30-day discount window facility where ABCP backed by eligible collateral is a permitted asset.
ABCP also became eligible for sterling long-term repo operations on Oct. 3. The European Central Bank (ECB) currently accepts ABCP as eligible collateral for its long-term repo facility. A large number of EMEA ABCP conduits have accessed the ECB repo facility over 2008.
Andrea Quirk, a senior director at Standard and Poor's, said that, despite the various options the ECB and Bank of England have for ABCP, European issuers have still opted for the U.S. market because it's more well-established. This, she said, is supported by December 2008 yearend volumes that show a just over 30% issuance decline by European sponsors and a 65% ECP issuance dip based on December 2007 numbers. "This will be a continuing trend into 2009," Quirk said. "A couple of programs amortized and re-opened just to take advantage of the Feds' CPFF program."
Some of the European conduit programs have U.S. issuers or both U.S. and European co-issuers, with U.S. players still selling paper at acceptable rates. Sponsors might choose to continue to fund through the U.S. - as there may be more demand and the financing costs may be better.
"The European ABCP market has always been much smaller and less liquid than U.S. CP, said Kevin Hawken, a partner at Mayer Brown International, adding that Euro ABCP volume increased in the last few years, but has now shrunk dramatically. "Conduits that can issue CP in either market have gone back to issuing primarily in the U.S. because even now the market there is more liquid, and, for the time being, the cost of funding is lower." This is even after including the cost of converting dollars to euro or sterling and locking in the exchange rates, he said.
Another aspect compounding the drop in issuance volumes is that European sponsors can look to other sources for funding, such as ECB repo funding, bond issuances guaranteed by relevant governments, and covered bond issuances.
Fitch Ratings said, however, that a few large, fully supported programs have maintained funding in the European ABCP market, and some programs, although primarily issuing in the U.S. CP markets, have maintained a minimal amount of issuance in the European ABCP market.
No Buyers
Another part of the problem is that European investors are more cautious about the credit underlying these vehicles. U.S. investors, although also wary and increasingly picky, are still buying the paper.
Moody's Investors Service noted that, as the market value of securities funded in conduits started falling, investors started taking a closer look at CDOs and RMBS in the conduits, and at other exposures with negative credit news. Transparency became a popular word when the crisis started, as some ABS investors found they didn't have all the information they needed to understand the underlying assets.
However, Hawken doesn't believe transparency was ever the main issue for ABCP. Traditional ABCP, which has bank liquidity support for the full amount payable at maturity, suffered by association with commercial paper issued by structured investment vehicles (SIVs), which relied primarily on the market value of underlying assets for liquidity, he said. "When the markets for structured finance assets dried up, SIVs that weren't rescued by their sponsors were unable to repay their debts, and their senior investors found themselves holding defaulted commercial paper," Hawken said.
For some money market funds and other conservative investors, that experience led them to avoid all ABCP. With time, investors are recognizing differences between ABCP issuers. "Asset performance is still stable; in some cases we have seen tightening covenants in underlying transactions," Quirk said. "Where it has been deteriorating, there has been very active management."
Quirk added that there is lots of information available and sponsors are very open with investors. The rating agencies have undertaken initiatives to make information readily available. For example, S&P is publishing monthly portfolio data, quarterly market commentaries and bimonthly transaction snapshots, and as of April 1, S&P will disclose the names of all counterparties that act as support for repayment of ABCP.
If the money market funds stay away, investors won't see the same return. "Eventually these funds will feel pressure and there will come a point where they will need to put their feet back in the water," Quirk said.
When investors do bite, it will likely be for more traditional programs and not the more creative ABCP programs (e.g., the market value programs) and securities arbitrage programs that burned many fingers. "Investors want to know what risks relate to the structure, and the natural evolution of the quest for more transparency means that some of the 'more involved' structures have fallen away," Samy said.
In fact, among conduit restructurings, arrangers are making sure that there is no transparency issue for investors relating to the restructurings. The overall aim is to make structures easier to digest. "Two years ago, the term ABCP meant a myriad of different types of products," Samy said. "Many of those structures have fallen away, and this may be a move in the right direction, because the market may regain a comfort level for ABCP (as it will refer to the more traditional, safer product) that will get investors back to the table."
Looking to the Domestic Market
There should naturally be a shift back at some point to some sort of short-term funding mechanism in the U.K. and Europe.
Aside from the several initiatives already functioning, the U.K. has recently unveiled its own version of the CPFF through a Bank of England program to support commercial paper purchases - the government is trying to make the short-term segment of the market work. The Asset Purchase Facility (APF) allows the central bank to buy a range of high-quality assets with the money raised by the Debt Management Office (DMO) through T-bill sales. The assets that will initially be eligible for purchase under the scheme will be high quality commercial paper, corporate bonds, paper issued under the Credit Guarantee Scheme (CGS), syndicated loans, and ABS created in viable securitization structures.
The new facility will initially incorporate commercial paper issued by U.K. corporates, both in the new issuance and secondary markets, subject to a minimum spread.
"Once the right type/level of government support is adopted in one jurisdiction, it will likely spread to other jurisdictions," Samy said. "I hope we are getting to the position where people want to be doing short-term financing deals again. Many bankers have indicated that the first spark of real recovery will begin in the short term markets."
No Crystal Ball
However, the recovery is sure to take more time. Conduits structures have the benefit of both the underlying financial assets and bank-provided liquidity and credit support, but both of these pillars are affected by the current financial climate.
Hawken said that the market expects to see some softening in the credit quality of commercial and consumer assets that are underlying traditional multi-seller commercial conduits. Even with troubled structured finance assets taken out, transactions backed by commercial and consumer assets might be stressed, as the recession continues to negatively impact the economy.
Conduits also face bank-related credit problems. According to S&P, the main driver of ABCP rating actions in 2008 were rating actions on the major bank liquidity providers, and not bond insurers or underlying asset deterioration. Quirk believes this trend will continue in 2009.
Hawken said, however, that he does not expect to see anything worse than the plunge in structured finance asset values over the last 18 months. "The combination of pressures on commercial and consumer assets and on banks means another difficult year, but the ABCP conduits will survive and in time the market will begin to grow again," Hawken said. "Likely we will see more modest annual growth rather than the kind of spectacular expansion we had from 2000 until 2007."
The ABCP [U.S. and European CP combined] market now is about the same size as it was in 2000 when it was considered healthy and mature. At over $600 billion, it is still a big market. "When investors start feeling that the main problems with banks have been worked out and the problems with structured finance have been worked on, then the market will begin to see a recovery," Hawken said.
At the moment, Hawken added, in ABCP as in other structured products, most activity has involved restructuring, such as changing programs to make paper eligible for purchase by government-sponsored liquidity programs. In multi-seller conduits, there are few new transactions, but conduit sponsors are upgrading existing transactions to add credit enhancement and adjust to current market pricing.
In terms of conduit structures, the trend of focusing on well diversified multi-seller exposure vehicles remains in place for 2009. In terms of asset types securitized by conduits, no significant shifts are visible according to Moody's asset breakdown data for EMEA conduit exposure. Trade receivables account for 19% of the amount of assets funded via all EMEA ABCP non-arbitrage vehicles, and car loans make up 13%.
Unicredit analysts said that the Basel II requirement to post capital as a liquidity provision to a sponsored conduit has a huge impact on former regulatory capital arbitrage opportunities, and does change the landscape for European ABCP programs. Further enhancement to the Basel II framework means that banks will no longer be allowed to recognize external ratings for commercial paper issued by an ABCP conduit in case the conduit is supported by the same (sponsoring) bank, and a capital deduction is considered for any ABCP held by the sponsoring bank itself, irrespectively of being booked in the trading or the banking book.
"ABCP is an advantageous and viable product, even if regulatory capital advantages are less; it still has a good future," Hawken said.
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