The following is the latest missive from Minyan Peter, author of popular articles like the Bank Earnings series.


Asset-backed commercial paper, or ABCP, represents short term debt issued by specially-formed special purpose entities, which is used to purchase financial assets (loans, leases, trade receivables etc.). Unlike your typical operating corporation, the source of repayment comes from either the cash flows of the underlying financial assets or liquidity lines provided by a third party bank. In most cases the liquidity lines cover 100% of the commercial paper, but there are instances where the underlying assets cash flows may cover some portion. Further, there are generally “coverage requirements” (minimum net assets) which must be met in order for the liquidity banks to fund. (This last piece is intended to distinguish “no capital required” liquidity lines from “capital required” letters of credit.

ABCP vehicles come in either single-seller or multi-seller formats, and, as the names imply, it is possible to purchase ABCP that is backed by only one kind of asset from one seller. The largest entities in the market generally have multiple asset types from multiple sellers.

Most of the special-purpose entities are established to achieve off-balance sheet financing (sale treatment) for the seller of the financial assets. Under current accounting rules, this requires a minimum of 3% equity in the special-purpose entity. As a general rule, more substantial “equity” is provided to the special purpose company through discounts or overcollateralization of the specific assets purchased from each seller.


What is the future of the ABCP market?

The whole premise of the ABCP market was that it enabled corporations to finance assets through less expensive means than bank borrowings. As the clearing price for ABCP has risen, however, that cost advantage has clearly declined. Further, as US consumer credit quality continues to deteriorate, I for one, expect that we will see additional migration of ABCP to bank balance sheets (whether through outright purchases of CP or drawn liquidity lines).

The systemic challenge, though, is liquidity. In order for the migration to occur, banks must be successful in raising additional funding to support higher asset levels at a time when capital is declining. Clearly the Treasury’s “super conduit” was an attempt to create additional system-wide liquidity to stabilize the migration process (Note that banks were offering backstop lines versus outright borrowings). While ABCP may become a thing of the past, I would not underestimate the effort that the banks, the sponsors of money market funds and the regulators will exert to ensure a smooth flow.