With just a few days left in February, it's likely the asset-backed commercial paper market will see its second straight month of contraction. Through last week the market was down about $17 billion from December's high of $726 billion (although the market did spike in early January to $740 billion before falling back for a month-end $724 billion).
In its February ABCP Paper Trail, Fitch Ratings suggested that the market may see an uptick in activity as "investors pursue a source of stability and quality in the face of an impending Iraq confrontation."
The current slowdown, however long-lived, was widely anticipated, and many industry players believe outstanding ABCP this year may trail 2002, marking the second consecutive year of declining volume. For the next several months, at least, ABCP players - especially the bank sponsors - will continue weighing the different restructuring strategies to avoid consolidation under FIN 46, the Financial Accounting Standards Board's reformed guidelines on treatment of special purpose entities.
According to Moody's Investors Service, several parties are considering structuring a rated subordinated tranche, equal in size to the expected loss via FASB's equations, into an ABCP conduit. This might allow a third-party investor to be deemed the majority variable interest holder, as it would assume the majority of the expected loss and the expected residual return. An industry accountant, speaking off the record, said this type of restructuring would theoretically satisfy the new standards.
"This seemed to be the angle people were approaching out in Arizona," said Sam Pilcer, head of ABCP at Moody's. "You could sell an expected loss tranche to an opportunistic, hedge fund-type investor that wouldn't be concerned with taking a large amount on its balance sheet."
Pilcer believes that sponsoring banks would favor this type of approach - maintaining control of the conduit - as opposed to transferring the reigns to a third-party asset manager in efforts to avoid consolidation, which is another angle some players are exploring.
In this sense, the expected loss investor would assume a sizeable debt exposure on its balance sheet, though realistically a small, determinable measure of risk. Rating an expected loss tranche is similar to rating program credit enhancement, Pilcer said, a methodology the rating agencies have developed over the past year or so for satisfying other regulatory provisions, such as the risk-based capital adequacy guidelines.
According to Deborah Seife of Fitch, rating credit enhancement would be applying elements of CDO ratings to the ABCP conduit. Some conduit are already issuing rated mezzanine notes that act as credit enhancement, such as Eureka Securitization, a Citibank vehicle.
Sunflowers for Algernon
Separately, it was learned last week that Sunflowers Funding Corp., a conduit administered by ABN Amro for the benefit of seller Bank Labouchere, has paid out in full, though has not been officially terminated. In its February newsletter, Fitch announced that it has withdrawn its rating on Sunflowers. Moody's has not taken any action. The program was $750 million in size last August.
Apparently, ABN Amro funded the entire portfolio out of the conduit, which primarily consisted of share leases originated by Amsterdam-based Bank Labouchere. Contacts at ABN Amro did not return phone calls seeking comment.
"Assets in the conduit were beginning to perform worse than expected," said a source monitoring to the situation. "They took the assets out of the conduit. It's my understanding that they are awaiting instructions from Bank Labouchere."
Defaults on the share leases started to creep up, presumably as a result of stock market losses, the source said.
Sunflowers, which is similar in structure to ABN Amro's Amstel - one of the market's largest conduits - was set up so that lower-rated Bank Labouchere would benefit from a cheaper cost of funds.
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