The $1 trillion ABCP market shows no signs of slowing down, with its low cost of financing and short-term flexibility. Still, professionals in the sector wonder if the surging repurchase agreement market, also known as repos, might one day take a significant bite out of commercial paper business.
For the past couple of years, dealers used commercial paper to fund the super senior tranches of certain asset-backed deals. More recently, however, repos appear to be taking the place of asset-backed commercial paper to fund those securities and CDOs, market sources said.
"A lot of repo money is available, to the extent that repo money could supplant commercial paper," said one person familiar with the market.
Case in point: Credit Suisse brought the $332 million Duke Funding High Grade II to market in January, funding at least part of the deal with repos.
"This is bad for the ABCP dealer community. Repo counter parties are dealing directly with asset sellers and providing funding through that mechanism," said a commercial paper market professional.
True enough; the cost of repos has gotten cheaper in the past two years, said James Croke, a partner in the capital markets department at Cadwalader, Wickersham & Taft. Repo spreads tightened substantially from about Libor plus 20 basis points about two years ago to the single-digit range over that benchmark today, Croke estimated.
Further, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 broadened the types of securities that can qualify as collateral in repo agreements. Currently, eligible securities include mortgage loans, mortgage-related securities and certain bankers' acceptances, along with the old standard, government securities.
While some ABS experts acknowledge that the use of repurchase agreements has grown substantially over the last couple of years, they say it poses no substantial foreseeable threat to the asset-backed commercial paper market.
"The commercial paper market has always been an important source of funding for the warehousing of assets, but repurchase agreements were also always an alternative," said Andrew Jones, a managing director at Dominion Bond Rating Service. He added that repurchase agreements used to be the primary sources of funding mortgage collateral before the development of the ABCP market.
Commercial paper conduits became a popular source of warehouse funding in the late 1990s, particularly after the liquidity crunch of 1998, which caused sellers to recognize the benefits of having diverse sources of funding, he said.
Broker dealers, who often provide warehouse funding, typically prefer to pull their credit lines in a liquidity crunch, instead of riding it out. In those situations - and others wherein liquidity dries up - asset-backed commercial paper is an even more important as an alternative funding source, said Jones.
And while spreads on repos have been tightening, commercial paper is historically cheap, and sometimes prices at about six basis points below the benchmark, said Croke.
Repos are more likely to be used by dealers that do not have access to liquidity needed to fund deals with commercial paper, said Devansh Patel, a director in Barclays Capital's CDO structured funds group. "It's another tool in the toolkit," said Patel.
Funding certain high-grade deals with commercial paper has brought a new investor base to the CDO product that traditionally had no access to it, further shoring up commercial paper position as a competitive funding source, he said.
As Croke sees it, the two techniques are compatible, especially because some dealers have figured out that they can use the asset-backed commercial paper markets to fund repo transactions.
"They have figured out ways to enable people to earn a positive spread through refinancing, issuing ABCP," Croke said. "It is a kind of merging of those technologies."
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