Intense 3Q, No Slowdown in 4Q
Asset-backed commercial paper outstandings1 for the third quarter of 1999 rose to a new high of $486 billion, up 12.5% from $432 billion at the end of the second quarter. The intense pace of growth in the third quarter was attributable primarily to market participants' expectations that investor appetite for ABCP in the fourth quarter would be tempered as a result of increased money market redemptions and other cash requirements associated with Y2K-related precautionary measures. Sixteen new conduits were rated in the third quarter, a figure roughly in line with the average number of conduits established per quarter over the previous eight quarters.
The continued growth of the market in the fourth quarter was a surprise to most. Leading market participants expected that by the end of October the pace of seller additions to existing ABCP conduits would probably slow, and, certainly, the rate of establishment of new conduits would all but halt in response to reduced investor demand for ABCP. However, the market continued to be quite robust in the fourth quarter, with a record number of 23 new ABCP conduits rated (see graph below) and ABCP outstandings rising to over $500 billion. Of note, nine of the 16 conduits established in the third quarter, and six of the 23 new conduits established in the fourth quarter, were established by non-US domiciled banks. This evidences the heightening interest in securitization in the European, Japanese and Australian markets.
Securities Arbitrage Programs Dominate
As Moody's Investors Service reported last quarter, the largest change in the ABCP market's program mix over the previous 18 months had been in the securities arbitrage segment, which was the fastest growing segment of the market. This trend intensified in the third and fourth quarters of 1999, and is likely to continue into the new millennium. Of the 16 programs established in the third quarter and 23 new programs established in the fourth quarter, securities arbitrage programs represented three and eight of the respective totals. As the number of new ABCP programs established has mushroomed, so has the predominance of securities arbitrage programs, which accounted for roughly 8% of the 47 programs established in 1997, 22% of the 53 programs established in 1998 and 36% of the 68 programs established in 1999. There are also several new securities arbitrage programs in Moody's ratings pipeline that are scheduled to come to market in the first and second quarters of 2000.
In addition to the eight new securities arbitrage programs established in the fourth quarter, several existing partially supported, multiseller conduits were amended to add securities purchasing capabilities. These conduits include ING Barings (U.S.)'s Mont Blanc Capital Corp., Nesbitt Burns' Fairway Finance Corp., Bankgesellschaft Berlin's BEST Funding Ltd., and Royal Bank of Scotland's Loch Ness Ltd. Now the vast majority of multiseller ABCP conduits have the ability to buy individual rated asset-backed securities or portfolios of these securities. Credit enhancement levels for such securities purchases in partially supported, multiseller programs range from 0% to approximately 15%, depending on the credit quality of the assets purchased and the structure of the program.
Financing of Synthetic Lease Structures Up
Synthetic leases were first financed in the ABCP market in the mid-1990s by Citibank. At that time, Citibank financed synthetic lease transactions through a few of its conduits using a creative structure that mitigated the risk of a single obligor exposure that defines this asset class. Since the mid 1990's, only a handful of conduits, other than Citibank's Charta Corp. and CXC Inc., financed synthetic leases because of this single obligor exposure risk. However, in recent months, synthetic lease deals have begun to find homes in other multiseller ABCP programs that have been able to mitigate the single obligor exposure risk in creative ways. For instance, in just the fourth quarter of 1999, both Dresdner Bank's Beethoven Funding Corp. and Bank of Nova Scotia's Liberty Street Funding Corp. added synthetic lease structures to their portfolios. In addition, Bank of America established Hatteras Funding Corp. in November of 1999 for the primary purpose of financing synthetic lease structures. To date, Hatteras has financed six such transactions and continues to build its synthetic lease portfolio. Hatteras mitigates the single obligor exposure risk by fully supporting the transactions with liquidity facilities. Moody's expects that transactions in this asset class will be seen in greater numbers in the ABCP market in 2000.
Liquidity Still Preoccupies Market
As Moody's reported in 1999, third-party liquidity support for ABCP programs continues to become increasingly expensive and more difficult to find. In fact, many market participants predict that unresolved liquidity restraints will ultimately lead to a slowdown in the growth of asset originations and, therefore, ABCP outstandings. In reaction to this shortage, ABCP program sponsors have continued to develop new and creative means of providing liquidity to their conduits. As reported last quarter, alternative sources of liquidity include harnessing the value of a program's assets in the securities arbitrage programs, signing up insurance companies as providers of liquidity, and increased popularity of the club deal. There has also been a greater use of liquidity notes (sometimes referred to as extendable commercial notes, or ECNs) with the launching of Bank One's Lake Front Funding Co. LLC, Alliance Capital Management's ASAP Funding Ltd. and MBNA's Emerald Certificates Program. Although the use of liquidity notes, or ECNs, can reduce the need for third-party liquidity in some ABCP programs, they may not be available to every issuer depending on the structure of the ABCP program. Further, these methods are not currently favored by sufficient numbers of investors to alleviate, in any real way, the so-called "liquidity crisis."
In response to these limitations on the current methods for reducing the needed amount of third-party liquidity, some issuers are taking new and unusual approaches to evaluating the need for third-party liquidity in their programs. Unfortunately, none of these new approaches are likely to be seen in the marketplace until very late in the year.
No Impact from Y2K
As predicted by Moody's and many other market participants, no Y2K issues disrupted or threatened the credit quality of any ABCP programs. Any issues programs may have had with seller compliance were resolved without incident and without increased defaults. ABCP program sponsors' systems functioned without significant glitches.
A Happy Ending for Bravo Trust 1997-1
In August 1999, in a series of downgrades Moody's lowered the rating on Bravo Trust Series 1997-1 Class A from Prime-1 to Not Prime. These downgrades paralleled a series of reductions in the rating of Integrity Life Insurance Co. ("Integrity Life"), which provided credit enhancement to the transaction. The downgrades of Integrity Life were prompted by concerns over the company's ability to meet the demands of short-term funding agreements, as well as financial difficulties at its parent, ARM Financial Group. In November, all of the Bravo certificates, including the subordinated certificates, were paid out at par with no loss to investors. At this point, there has been no request by the insurance regulator overseeing the affairs of Integrity Life for the Bravo Trust to return any payment made to the trust by Integrity Life.
Predictions From The Market Pros
Moody's polled some of the leading market participants for their predictions of the size of the ABCP market by year-end 2000. The consensus appears to be that outstandings will grow to approximately $600 billion, representing a growth rate of roughly 20% from estimated 1999 year-end outstandings of $500 billion.
Changes in the Top Ten Administrators
Gordian Knot Ltd., which sponsors the Sigma Finance Inc. and Sigma Finance Corp. securities arbitrage programs (one arm issues ABCP and MTNs in the euro markets, the other arm issues in the US market), is back on the list at number eight, with 2.9% of the market, after several quarters off the list.
Deutsche Bank, which was not on the list for the second quarter of 1999, is back on with a 2.8% share of the market. Deutsche Bank is commonly one of the top ten adminstrators.
The two administrators that appeared in the second quarter top ten list but were replaced this quarter by Gordian Knot and Deutsche Bank are ING Barings (U.S.) and Rabobank Nederland.
1 - Throughout this article, the term "outstandings" refers to average daily quarterly ABCP outstanding, as opposed to outstanding ABCP at a particular time.