When the first extendable ABCP programs began drifting into the multi-seller segment of the market in 2001, issuers attributed it to a liquidity crisis. However, some investors scoff at the notion that the advent of extendable paper has been in response to investor demand. Instead, they claim, the technology is used primarily as a way of bypassing bank liquidity and improving the profitability of the conduits.
A panel of four investors sat down with ASR's Sarah Mulholland to air their thoughts on the issue; Barry Weiss, Vice president/portfolio manager, Oppenheimer Funds, Michael Egizio, Senior analyst, taxable debt, Northern Trust Global Investments, Natalie Metz, Vice president/senior investment analyst, Federated Investment Management Company, Matt Grimes, Managing Director, fixed income credit research,Wells Capital Management
ASR: Are investors adequately compensated for buying this paper?
Weiss: We don't think there's adequate compensation from this type of product. You are selling an option in the sense that you are allowing the issuer to extend you, and is that option worth just one basis point? Our viewpoint is no.
Egizio: If you decompose some of these programs, you have the credit risk of the asset. Additionally, you have the administrative or the seller servicer risk from the bank that's monitoring these assets. You also have the extension risk, as well as some liquidity risk here because as an investor, you're being asked to provide that liquidity. If you start adding it all up, we come to the same conclusion that there is not adequate compensation for the risk.
Metz: We do not feel we are adequately compensated up front for the issuer's option to extend. Often these programs start smaller, and you might have a five to ten basis points pick-up. But once the program gets to a meaningful size where some of the larger investors would take a look at it, the price is so collapsed that it's no longer attractive.
ASR: The consensus is that these programs average a pick-up in yield between one and three basis points. How much additional yield do you feel would be appropriate to offset the risk?
Egizio: If you look at a traditional ABCP program with bank provided liquidity, that bank receives a ten basis point commitment fee to provide liquidity for that program. If the conduit does not have to pay that fee to the bank, and I as an investor am being asked to provide that liquidity, then I should get some return. I should get some, if not all, of that fee.
Metz: I agree. We also feel we should be sharing in the savings that would be paid to the bank liquidity providers. A lot of times we're told that investors might not get the basis points up front, but that if it extends, you'll get Libor plus 25 basis points, for example. However, that has never been tested in the market. So we don't know if Libor plus the 25 basis points is true par based pricing at the time of extension.
Weiss: If I am told that I will get between 25 and 50 basis points in the event of an extension, I say that number is irrelevant to me. Somebody could throw out Libor plus 200 basis points, and it would still be irrelevant. If you extend a program, this is a big problem for everybody, and I'm unlikely to get the 200 anyway.
ASR: How large a portion of the ABCP market is currently being offered as extendable? Do you expect that percentage to increase?
Grimes: At the end of 2003, the total ABCP market was at $717 billion, and the extendable component of that was at $62 billion, which was about 8.6%. I am guessing that level will show modest growth for the end of 2004. There are several forthcoming changes in the banking regulatory market concerning how they're going to be able to book liquidity going forward. This could increase the potential drain on the bank liquidity availability, which would increase the attractiveness of the extendable marketplace.
Egizio: Extendables are here to stay, and are going to be marketed aggressively to investors. We're going to continue to see tweaks and changes and different use of technology in some of these programs.
ASR: What should investors look for when they are looking to differentiate one extendable program from another?
Weiss: From a structural standpoint, they're not all created equal. Some are extended three days, and some are extended more than 200 days. There are huge differences, and we look at all of these things from a relative value standpoint; whether we like the sponsor, whether we like the collateral, and whether we like the structure.
Metz: There are some inconsistencies in the marketplace to watch for. For example, how are investors booking their securities? We would prefer booking these extendables to both their expected maturity date for our effective average maturity calculations and then also to the legal final maturity date for SEC average maturity calculations. Investors should also focus on the notification process of these programs. If a program were to extend, how are investors notified, by what entity are they notified, and in what time frame?
Also factor in the experience of the administrator with securitized assets, as well as with the operations of an asset-backed CP conduit. Some of these are new entrants as far as single-seller type programs are concerned, let alone extendable ones. One last point is the length of the extension period. If the underlying assets are fast paying assets, then why the need for such a long extension period? The extension periods are definitely for the benefit of the issuers and not the investors.
Grimes: I would like to reiterate Natalie's point about the lack of uniform standards in this marketplace. This is an untested marketplace, so you don't know what kind of stress an extension will cause in the back office. If you have an operational hiccup and get stuck uninvested or overdrawn, your additional costs could erode any yield premium earned.
ASR: What would the impact of an extension event be on the ABCP market?
Grimes: I'm concerned about some level of contagion across the marketplace. The liquidity on this product is really driven by the investors in the marketplace. If you start to lose investors in the marketplace, the liquidity in this paper starts to go away. If you then saw extensions coming in across the board, it would be a big concern
Weiss: You will have a lot of people all trying to dump out of that paper. I can't even imagine what the bids would be. There is a good chance there wouldn't even be a bid. There would just be an indication what your paper was worth.
Egizio: Everybody asks what would happen if you got extended. But first we have to ask: What could cause you to get extended? There could be any one of a myriad of reasons some of these programs get extended. Some of the newer programs have very ill defined extension triggers. You could run into a situation where the underlying administrator of these assets is somebody new to this market, and they have never been able to fund this way before. They may look at the extension terms and find they can get Libor plus 25 for the next 300 days and decide that's a great deal.
ASR: To what length do you think issuers are willing to go in the event of a trigger to prevent the extension?
Weiss: It really depends on the issuer. If they're going to tap the ABCP market all of the time, and they need that kind of financing, obviously, they're more driven to make things right. But if you're talking about an issuer who was never a part of that market in the past, I would question how far that issuer would be willing to go. It may be better for that issuer to let that program extend and perhaps wind down. At the end of the day, they can likely fund themselves somewhere else.
Egizio: In the vast majority of these programs, the extension would be caused by an inability to role the commercial paper. If something can't get rolled, then you look to the dealers, and if there is stress at an issuer, the last thing a dealer is going to do is try and look out for that issuer's best interest. The dealers are in it for their own interest.
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