Things will never be the same in the extendible note (EN) portion of the ABCP sector, and that is the way investors want it. The buy-side community made its wishes plain over the past two weeks, firmly refusing to buy much new extendible note ABCP debt, especially the sort that funded MBS and CDO debt via single-seller vehicles.
By press time last week, skittish investors had all but retreated from that corner of the ABCP market, destabilizing the sector and delivering one bad day after another. Consequently, EN paper volume, which stood at about $185 billion at last count, should be dramatically scaled back by the time the market normalizes again. Pushed to the heights of frustration, according to one market professional, some dealers took the drastic step of practically threatening investors: either roll paper at wider spreads or have the maturities extended anyway.
Several EN programs exercised their extendible features earlier last week, according to Fitch Ratings. Still, the rating agency said, typical assets used to secure EN programs include credit card and trade receivables, or residential mortgages and rates securities that have robust predictable cash flows and typically are readily marketable.
"Friday [Aug. 3] aside - which was probably the worst day I've ever seen on the market, worse than 1998 - we have a tale of two markets," one ABCP professional.
Those two markets are the broad ABCP sector and the more specialized extendible-note portion. The latter, also known as secured liquidity notes, has been impaired by lack of investor support. Consequently, issuers are trying to reduce their reliance on the product and take money out as fast as they can, said one market source. Light EN rollover pushed spreads out as far as 60 basis points over ABCP pegged against one-month Libor, even if they were rated A1+' or P-1+,' according to a market source.
"Almost nothing is done in one month [durations] or longer," he said, adding that dealers who managed to trade ABCP against the overnight market saw spreads at about Federal Funds rate plus 30 basis points and more, in some cases. Outstanding volumes of ENs have fallen drastically in the last two weeks, some say by as much as $50 billion.
Spreads in the broader ABCP market were hit, too, being pushed out by as much as 10 basis points over Libor on multiseller programs sponsored by larger banks, another ABCP sector professional said.
"It is serious," he said. "I think what's going on is ... the ABCP market has been used as a warehouse funding vehicle for the subprime mortgage market. That has really caused investors in the ABCP market to become extremely cautious."
Single-seller mortgage ABCP conduits had about $30.6 billion in outstanding paper by the end of July, according to figures from a Moody's Investors Service report published last week. Coincidentally, the rating agency debuted its U.S. ABCP Single-Seller Mortgage Market Snapshot publication the very week that the ABCP market began to feel parched from a contraction in liquidity. Around the same time that Moody's issued its report, the Federal Reserve estimated the amount of outstanding asset-backed commercial paper to be $1.1 trillion.
Broadhollow Funding, which is sponsored by Melville, N.Y.-based .American Home Mortgage Investment Corp. and which funds prime agency, jumbo and Alt-A mortgage loans, was the most visibly destabilized program. The company filed for Chapter 11 bankruptcy protection last week after being unable to meet pending margin calls, and it laid off about 6,000 people, or 90% of its staff. Moody's downgraded the conduit's $138 million Variable-Rate Subordinated Notes, secured by whole loans, to Ba1', from Baa2', and they were on watch for another possible downgrade. Likewise, .Standard & Poor's placed ratings on the conduit's triple-B' notes from Series 2004-A and 2005-A on CreditWatch negative.
For Broadhollow Funding's part, the sponsoring company's bankruptcy meant that its conduit could no longer buy additional mortgage loans, according to S&P. Therefore, all collections and sales proceeds, along with swap payments on any of the assets, will be held to pay off Broadhollow's secured liquidity notes as they mature.
Mortgages are not the only ABCP asset that are unwelcome. The Altius Funding and Citius Funding programs, which fund CDOs and are sponsored by .Aladdin Capital Management, have also come under pressure.
"People are not as sanguine about the ABCP market as they were several months ago," one market source said.
CDO managers are apparently spending most of their days educating investors about the underlying credits of the paper they hold and convincing them to resist pressure to trade out of the bonds.
"A lot of times, you have to explain that if you trade out of a bond, you are going to drop 20 or 30 basis points, and that is bad," one professional said. With cash assets, or assets that are rolling off, one could replace them with much cheaper assets, and in some cases cheaper assets of higher quality.
Another strategy would be to stay at the same credit and get a lot more spread, says one buy-side professional who prefers to hunker down until liquidity returns to the ABCP sector.
Similarly, the structured investment vehicle (SIV) market saw issuance fall off, mainly as a result of a tug of war between investors who kept bidding spreads wider and the dealers who refused to allow them to reprice the market. In the end, as far as some see it, the customer might prevail. One-year paper pegged against one-month Libor was attracting interest at three or four basis points over, after widening out by about five or six basis points, said one market participant.
"It is fair to say that issuance has fallen off dramatically and that the market is going to need to reprice in order to regain access [to investors]," a market source said. Last Wednesday was the first day in almost a week that SIV managers and dealers broke through the pricing barrier and began selling paper at wider levels.
The slowdown in EN issuance is not expected to affect long-term production of ABCP drastically. Indeed, securities issued via ENs might eventually be redistributed through regular unsecured ABCP vehicles, said a market source. Extendible notes, however, will continue to be viewed as impaired.
"That extendible market, to survive, has got to be smaller," he said.
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