What's Happening in ABCP
An excellent explanation of what is happening in ABCP From the Financial Times:
The SIV's (structured investment vehicles) or conduits fund their purchases with short-term borrowings in which interest and principal payments are backed by financial assets that are deemed to have stable cash flow.
Collectively this so-called “asset-backed commercial paper” – or ABCP – lasts for anything between a few days and a few months before needing to be refunded.
Everything in this market depends on investors in the ABCP market maintaining their faith in the programmes and the assets they hold.
With the current rush for the exits in many structured credit markets, this faith has been evaporating wholesale.
No investors are sure exactly what assets the SIV's or conduits are holding, or how damaged those holdings might be.
Non-SIV funds – such as those run by BNP, Axa and others that have hit trouble recently – were able to stop investors pulling their cash out, SIVs and conduits who see their funding expire on a regular basis have no such luxury.
Mainstream banks must step in to provide finance if the SIV cannot raise commercial paper in the normal way, unless the SIVs’ assets suffer significant ratings downgrades.
The rush to sell structured products by hedge funds facing redemptions and other investors meant those market values that could be ascertained were being marked down heavily.
As a result, by mid-July some investors decided to stop buying ABCP paper from SIVs suspected of subprime exposure.
The German bank IKB was an early victim, it had a conduit – called Rhineland Funding – with almost €20bn worth of outstanding commercial paper in the markets in July.
In mid-July, ABCP investors refused to roll over some of these notes. Rhineland asked IKB to provide a credit line.
But it appears the German bank did not have enough cash to meet this request and was unable to liquidate enough assets to plug the gap.
This threatened to trigger IKB’s collapse, until KFW, the state-owned German bank, stepped in and offered an €8bn credit facility.
By early August, the problems in the ABCP market had become so serious that some European banks were preparing for additional calls on credit lines to SIVs.
But the banks are also grappling with a backlog of unsold leveraged loans, which is placing additional pressure on their balance sheets.
So early this month some European banks – and a few US institutions as well – quietly started trying to raise new credit lines themselves.
That, however, triggered additional alarms. Consequently, by the middle of last week, some banks started shutting credit lines to a sweeping list of institutions.
Commercial paper interest rates have not yet fallen, irrespective of central bank actions. In New York on Friday, they closed at their highest level for six years.
“Nobody is going to handle commercial paper if they think the Fed could be about to cut rates or do something else completely unexpected overnight,” explains one insider.
It is becoming clear central banks cannot resolve the biggest problem:
a lack of clarity about valuations in structured credit markets and the almost complete loss of confidence that is infecting even the biggest and most diversified of conduit-type programmes.
The SIV's (structured investment vehicles) or conduits fund their purchases with short-term borrowings in which interest and principal payments are backed by financial assets that are deemed to have stable cash flow.
Collectively this so-called “asset-backed commercial paper” – or ABCP – lasts for anything between a few days and a few months before needing to be refunded.
Everything in this market depends on investors in the ABCP market maintaining their faith in the programmes and the assets they hold.
With the current rush for the exits in many structured credit markets, this faith has been evaporating wholesale.
No investors are sure exactly what assets the SIV's or conduits are holding, or how damaged those holdings might be.
Non-SIV funds – such as those run by BNP, Axa and others that have hit trouble recently – were able to stop investors pulling their cash out, SIVs and conduits who see their funding expire on a regular basis have no such luxury.
Mainstream banks must step in to provide finance if the SIV cannot raise commercial paper in the normal way, unless the SIVs’ assets suffer significant ratings downgrades.
The rush to sell structured products by hedge funds facing redemptions and other investors meant those market values that could be ascertained were being marked down heavily.
As a result, by mid-July some investors decided to stop buying ABCP paper from SIVs suspected of subprime exposure.
The German bank IKB was an early victim, it had a conduit – called Rhineland Funding – with almost €20bn worth of outstanding commercial paper in the markets in July.
In mid-July, ABCP investors refused to roll over some of these notes. Rhineland asked IKB to provide a credit line.
But it appears the German bank did not have enough cash to meet this request and was unable to liquidate enough assets to plug the gap.
This threatened to trigger IKB’s collapse, until KFW, the state-owned German bank, stepped in and offered an €8bn credit facility.
By early August, the problems in the ABCP market had become so serious that some European banks were preparing for additional calls on credit lines to SIVs.
But the banks are also grappling with a backlog of unsold leveraged loans, which is placing additional pressure on their balance sheets.
So early this month some European banks – and a few US institutions as well – quietly started trying to raise new credit lines themselves.
That, however, triggered additional alarms. Consequently, by the middle of last week, some banks started shutting credit lines to a sweeping list of institutions.
Commercial paper interest rates have not yet fallen, irrespective of central bank actions. In New York on Friday, they closed at their highest level for six years.
“Nobody is going to handle commercial paper if they think the Fed could be about to cut rates or do something else completely unexpected overnight,” explains one insider.
It is becoming clear central banks cannot resolve the biggest problem:
a lack of clarity about valuations in structured credit markets and the almost complete loss of confidence that is infecting even the biggest and most diversified of conduit-type programmes.
Comments