Lift-off for asset-backed CP?
The market in asset-backed commercial paper, which has grown to a huge size in the US, is still in its infancy in Europe. But the increasing use of the ABCP market by Europe's largest banks, the growing desire among investors for credit products - and the fact that the euro's arrival means that asset pools can be securitised much more easily - should mean that the product finally starts to take off in the European market.
THE EURO-COMMERCIAL PAPER market may be up and running, but the asset-backed ECP market is still on the starting blocks.
While outstandings of ABCP doubled to nearly $400bn in the US between 1996 and 1998, accounting for 40% of all dealer-placed commercial paper, the asset-backed sector in Europe is worth a meagre $11bn.
Kevin Grainger, associate director at Barclays Capital, is in no doubt as to where the problem lies. "The investor base in Europe needs educating, badly," he says.
European investors' reluctance to buy ABCP stems from a simple shortcoming: an unsophisticated approach to risk. Unlike the mainstream CP market, investors do not buy ABCP on the basis of credit rating or name recognition, but through understanding the underlying risks.
To date the problem in Europe has been that relatively few investors have the capability, or the inclination, to develop more advanced risk analysis. Without such a change, ABCP is going to struggle to take off.
"A lot of managers make snap investment decisions: 'I don't understand it therefore I'm not going to buy it'," says Grainger. "But they could get so much more value out of so many more issuers if they had their own credit departments."
Where ABCP is concerned the added value is straightforward. In return for doing the extra work to understand the risks involved, the investor will get a healthy pick-up in yield.
Given that most ABCP programmes are rated A1/P1 or higher, that should be very attractive from a credit perspective. "Many investors feel that ABCP offers good value for the credit, whereas A2/P2 may be expensive because of the preferential access that some issuers get to domestic markets," says John Delaney, executive director at Goldman Sachs.
The growth of ABCP in Europe should give investors access to a reliably liquid asset class. "We believe that ABCP should be an attractive security for investors given that these issuers tend to have a consistent need for funding," says Delaney,
There is no doubt that banks and finance companies are becoming increasingly interested in the opportunities for securitising European assets. For banks it offers the chance to get underperforming assets off their balance sheets, while continuing to service their clients and open up new sources of revenue.
European banks already make up five of the top 10 sponsors of asset-backed programmes in the US market. Deutsche Bank, for example, has 10 ABCP conduits - five in the US, three in Europe and two in Australia.
The arrival of the euro also makes it easier to pool assets or receivables from different European countries into a single portfolio for securitisation.
Barclays Capital runs an ABCP conduit called Sceptre which had researched a trade receivables securitisation involving 13 different currencies. At the time, the inefficiency of the currency swap market meant it would have been impossible to make a profit on the transaction. But with the removal of 11 currencies from the picture, such opportunities will become increasingly attractive.
Such developments are attracting the attention of securitisation experts on the other side of the Atlantic, according to Grainger at Barclays Capital.
"The asset-backed market is driven by two things, both emanating from the US," he says. "One is the fund managers who understand these vehicles are coming to Europe. The other is that US conduits are having to look elsewhere to get value.
"They're getting squeezed in the US, and are not going to find the assets to put into new conduits. It's got so esoteric in the US that they're having to securitise rock band record receipts. In Europe we're still on mortgages."
For the ECP market, the big question is whether conduit managers will try and fund transactions in Europe, or prefer to raise their cash in the more liquid and reliable US market.
For investors seeking to understand ABCP there are two levels of risk they need to consider: their exposure to the underlying assets; and their exposure to the service provider, or programme sponsor.
Asset-backed CP conduits are typically run by a bank or finance company through a bankruptcy remote special purpose vehicle (SPV). The conduit issues CP which the SPV uses to fund a pool of trade receivables or term assets - which may be purchased from a third party, or from the balance sheet of the sponsoring institution.
An investor's exposure to the underlying assets will depend on whether the CP programme is fully or partially supported. In a fully supported programme, repayment of CP is guaranteed by some form of credit agreement (such as a surety bond, or third-party guarantee), which covers all the credit risk on the underlying portfolio of assets.
In this case, the investor is not exposed to the risk of default on the underlying assets, but rather to the credit risk of the programme's guarantor.
A partially supported ABCP programme repays CP from the cashflow or market value of its asset pool. The investor takes the risk of losses on the underlying assets exceeding programme-specific limits.
Another important distinction is between single-seller and multi-seller conduits. Single-seller ABCP programmes raise cash to finance assets purchased from a single source, for example the loan portfolio of a specific bank, or credit card receivables from one company.
A multi-seller conduit takes assets from a variety of unrelated sources and pools them into a single portfolio, which it then finances by issuing CP.
Within an ABCP conduit, each specific pool of assets will have its own credit enhancement which ensures that pool is structured to a level of credit quality consistent with the conduit's overall credit rating.
In addition, a second layer of credit enhancement covers the programme as a whole - often in the form of an irrevocable loan facility, letter of credit or surety bond from a monoline insurer, where the third-party credit enhancement provider has a credit rating on a par, or higher, than that of the CP issuer.
Just as with ordinary CP issuers, ABCP also includes protection against liquidity risk in the event that disruption to the market, or other events not relating to the credit of the asset portfolio, means the issuer is unable to rollover CP.