Sub-prime ripples spread to commercial paper
Lucrative source of funding for companies under pressure, banks nervous
(NEW YORK) Trouble is mounting in the US$2.2 trillion commercial paper market, and further deterioration could trigger problems for banks that would rival what they’ve suffered from the sub-prime crisis.
While the problem could still subside, and there are no signs of a full-blown panic, at least five issuers of asset-backed commercial paper have had trouble refinancing that debt when it matured, forcing them to make investors wait before getting repaid. The asset-backed notes now makes up US$1.15 trillion - or half of all commercial paper.
Standard and Poor’s has warned that it may downgrade several issuers of commercial paper, a short-term IOU issued by companies that promise to repay the loans typically within a period of weeks or months. In these cases, the commercial paper was backed by residential mortgages.
Across the border, banks are refusing to supply emergency financing for 17 Canadian asset-backed commercial paper issuers managing funds of C$27 billion (S$38.5 billion), after they failed to sell short-term debt.
These developments have raised concerns as until now the crisis in the credit markets has been limited to problems related to sub-prime mortgages, those given to borrowers with questionable credit histories. But as these troubles seep into other parts of the securities markets, fears of losses are rising in unexpected places.
The fear now is that investors will be less willing to buy asset-backed commercial paper, which has provided a lucrative source of funding to companies.
If troubles among issuers spread, investors could suffer, but so could banks, which are most likely to be on the hook if issuers cannot sell new asset-backed commercial paper.
‘Asset-backed commercial paper problems could be much worse than what we saw in the sub-prime market,’ said Josh Rosner, an analyst at independent research firm Graham Fisher in New York.
In some cases, banks may have sold bad loans to commercial paper issuers, which would only magnify trouble in the market, experts said.
Mr Rosner was a long-time critic of sub-prime mortgage lending practices and foresaw many of the difficulties in that market, and if he’s right about asset-backed commercial paper problems, bank earnings could suffer further after already getting hit by exposure to mortgages. Loans used to finance acquisitions might be hard to parcel out to other investors.
Many investors and dealers downplay the extent of potential problems in the US$1.15 trillion asset-backed commercial paper market. The type of commercial paper that is struggling, known as extendible ABCP, makes up a relatively small portion of the total, they say.
‘The whole market has been tainted by a few deals. We see it as an opportunity to add to our positions,’ said Patrick Ledford, chief investment officer at money market fund The Reserve Fund, which has some US$67.5 billion of money market assets under management, late last week.
Generally, when ABCP matures, it is refinanced with new commercial paper. If it cannot be refinanced, banks pay back investors and seize the collateral, assuming the performance of the entire portfolio of collateral has not declined too much.
With extendible ABCP - where most of the trouble in the US has been found - if the paper cannot be refinanced, the issuer has the option to extend the maturity of the debt until a particular date.
Dealers estimate there is about US$160 billion of extendible ABCP outstanding in the US.
Issuers in Europe and Canada have also faced difficulties. Germany’s IKB Bank had the eighth-largest ABCP programme in Europe, the Middle East, and Africa as at the end of May, and was forced to move bad sub-prime assets from its conduit onto its balance sheet, analysts said. German banks clubbed together to give IKB more capital.
Some analysts see these cases as a taste of more to come.
Some dealers may have put bad loans into these conduits as a way to offload them to investors, said Graham Fisher’s Mr Rosner. When investors wake up to this fact, they may be reluctant to buy ABCP, leaving banks on the hook.
Several dealers said that was an unlikely scenario. Banks’ credit groups and rating agencies carefully monitor the collateral that is placed into ABCP funding vehicles, and generally it is of high credit quality, one dealer said.
But Michael Parker, chief executive at Evergreen Collateral Consulting, said that he has seen asset-backed commercial paper deals that have bought assets like equity bridge loans, or loans made to private equity firms to help finance the equity portion of leveraged buyouts. Often, the trouble comes from smaller banks that are just starting their conduits.
‘When you’re small, and you have to build mass quickly, sometimes you put strange assets into the conduit,’ Mr Parker said.
Mr Rosner noted that rating agencies failed to detect bad debt for bonds backed by sub-prime mortgages, and lightning could strike twice.
‘We’re seeing a big adjustment in the cost of capital, and that could make it uneconomic for many to play and leave banks holding a lot of losses,’ Mr Rosner said. — Reuters
Source : Business Times - 16 Aug 2007
Singapore Property - Buy , Sell , Rent , Invest
Mindy Yong
(+65)91002985
mindy@mindyyong.com
Obama picks Leon Panetta as CIA head »« A business continuity plan is vital
