Raise your hand if you lived through the Great Recession.
Now keep your hand raised if you can define Asset-Backed Commercial Paper.
If you put your hand down, then truth be told, you didn’t really live through the Great Recession. You may have survived it, but to have lived it, is to know what caused it.
According to a recent panel during the Structured Finance Industry Group conference in Las Vegas, ABCP will remain an important funding product for the economy for years to come.
Commercial paper is a security issued by large banks and financing firms, used to meet short-term obligations. The funding can be for overnight liabilities and usually mature in less than a year. These corporations may use assets, such as real estate, to back the paper as collateral.
This note from the history of the Federal Reserve charts the descent into the Great Recession, and the role ABCP played:
The decline in home prices helped to spark the financial crisis of 2007-08, as financial market participants faced considerable uncertainty about the incidence of losses on mortgage-related assets. In August 2007, pressures emerged in certain financial markets, particularly the market for asset-backed commercial paper, as money market investors became wary of exposures to subprime mortgages (Covitz, Liang, and Suarez 2009). In the spring of 2008, the investment bank Bear Stearns was acquired by JPMorgan Chase with the assistance of the Federal Reserve. In September, Lehman Brothers filed for bankruptcy, and the next day the Federal Reserve provided support to AIG, a large insurance and financial services company. Citigroup and Bank of America sought support from the Federal Reserve, the Treasury, and the Federal Deposit Insurance Corporation.
By 2009, the popularity of the product was in a massive decline, especially as the CDOs that backed the ABCP spiked in defaults.
"We are constantly asked when the US ABCP market will stop dropping in terms of outstandings," a report from Credit Suisse said at the time, "and we must be constantly reminded that we are still in a severe consumer recession, the term securitization market is still operating with a government lifeline, and the ABCP market itself still has government lifelines pumping through it; however, thankfully, the ABCP-related government programs are only being marginally used."
But today, with the performance of lending assets performing at historical highs, ABCP is coming back in style as a short-term financing option.
It needed some help to get there.
“Overall lending has evolved substantially, with issuers becoming more comfortable with existing regulation and technology contributing to the proliferation of new market entrants including FinTech companies and global alternative asset managers whose appetite for shorter term products, such as ABCP, has grown considerably,” a report on the panel from Standard & Poor’s noted today.
Here are the 4 reasons S&P cites for a strong ABCP market going forward:
- ABCP sponsors have satisfied the Risk Retention regulatory requirements, typically by purchasing 5% of their conduits’ outstanding ABCP. A recent court ruling that exempts CLOs from holding 5% capital for every transaction could potentially extend to ABCP, freeing some sponsors from the capital burden. Overall, issuers appear to be indifferent to the ruling given the time and effort they’ve already incurred in complying with the existing standards.
- While in the past, issuers and investors had opposing views on risk retention, they seem to have achieved a middle ground. Issuers became accustomed to holding 5% capital while investors became more comfortable with the quality of the assets.
- Due to Money Market reforms, the ABCP investor base has shifted dramatically from the prime institutional funds to non-2a7 funds, such as private liquidity and government funds.
- Basel’s Simple, Transparent, Comparable (STC) and Simple, Transparent, Standardised (STS) legislative frameworks scope in ABCP and establish strict criteria that both individual sellers (“transaction level”) and sponsors (“conduit level”) must meet to attain more lenient capital treatment. In the US, many bank conduit sponsors, which are already accustomed to strict capital requirements, see the costs of compliance out-weighing the cost of non-compliance. Their European counterparts, however, may see elevated capital levels for both STS and non-STS securitized positions.
“Repatriation of money in the wake of tax reform could give a temporary lift to the ABCP market as corporate treasurers, with new cash on hand, explore available short-term investment opportunities,” the S&P report concludes.