In recent weeks, both commercial paper and asset-backed commercial paper supply have rebounded after declining sharply the past 3 1/2 years. (See the Federal Reserve's "CP Outstanding" totals here.) With the market recovering, BofA Global Capital Management, manager of the BofA Money Funds (formerly the Columbia Money Funds) just published the timely, "Asset-Backed Commercial Paper: A Primer. The white paper, subtitled, "ABCP Delivers Several Benefits to Cash Investors, Enhanced Diversification and Attractive Yields Chief among Them," explains, "With diversification benefits, flexible terms, transparency, and a historic yield advantage relative to other cash investments, asset-backed commercial paper (ABCP) has been a sound addition to cash portfolios. In the Q&A below, Frank Gianatasio, a senior fixed income analyst at BofA Global Capital Management, describes the mechanics and potential benefits of ABCP.
The Primer asks, "Q. First, what is ABCP?" It answers, "A. ABCP is a short-term, senior-secured debt instrument collateralized by a variety of asset classes, such as credit card receivables, student loan payments and auto loan receivables. In the case of a specific ABCP credit, the investor's interest payments emanate from the pool of assets backing the credit, e.g., borrowers' monthly credit card payments. When the debt matures -- typically between 30 and 270 days -- the investor receives a principal payment that is funded either from the collection of the credit's assets, from the issuance of new ABCP or by accessing the credit's liquidity facility, a key feature of ABCP. Typically the liquidity facilities are structured to equal -- if not exceed -- the size of the ABCP program."
It continues, "Q. How is ABCP created? A. The issuance of ABCP begins with the seller of the security's underlying assets, e.g., a bank that wants to sell its credit card receivables or the financing arm of a car company that wishes to sell its auto loan receivables. The seller sells its receivables -- 'the assets' -- to a Special Purpose Vehicle (SPV), which is set up by a 'sponsor' (a bank or other financial institution) to issue ABCP. The SPV also is known as the 'conduit' because it is responsible for collecting and disbursing funds generated by the receivables to the ABCP credit's investors.... Thorough analysis of the strength of the sponsor is very important because the sponsor typically provides significant program-level credit enhancement and liquidity facilities that are designed to protect investors from potential credit losses and to provide liquidity in the event of a market disruption."
BofA Global's paper queries, "Q. What advantages does ABCP present relative to other cash investments? A. One major advantage is the diversification benefit, which accrues, to a large extent, from the risk profile of ABCP. First of all, ABCP investors are exposed primarily to the risks inherent in the underlying asset pools rather than the credit risk of a single financial institution or other issuer. Those underlying asset portfolios are well diversified. An ABCP issue may be backed by several distinct asset classes from a variety of sellers. This compares to standard commercial paper (CP) issued by a bank or other corporate entity, in which the investor is exposed to the risk of a downgrade of the issuer's debt or to an outright default by that issuer. The fact that ABCP is issued by the SPV helps insulate investors from the sponsor's other balance sheet risk. Therefore, in the event of a sponsor's bankruptcy, ABCP investors are not 'in line' with other creditors. Again, ABCP risk is secured by the underlying assets of the conduit, and investors have claim to those assets."
The Primer then asks, "Q. How does ABCP's yield compare to that of commercial paper? It says, "A. Historically ABCP yields have been higher than unsecured CP yields. This is somewhat counter-intuitive, as investors in ABCP earn more for taking a secured risk than a CP investor earns for taking an unsecured risk. The reason for that is that compared to CP, ABCP is understood and followed by a smaller group of investors. Some investment firms may not be sufficiently staffed or have the expertise necessary to analyze ABCP programs. The smaller buyer base means ABCP must offer a yield premium to attract investors. Money market funds can benefit from this slight pick-up in yield."
It adds, "Q. We saw during the global financial crisis that liquidity can dry up very quickly during a market disruption. How large and liquid is the ABCP market? A. As of January 28, 2011 there was $383.0 billion in ABCP outstanding, which accounts for approximately 35% of all commercial paper issuance in the U.S. Liquidity in the ABCP market is very robust. We know the market is broadly supported by many large institutional cash investors that are consistent buyers of ABCP, and there are at least two to three dealers on each ABCP program. In addition, every ABCP program is structured with at least 100% liquidity support so in the event of a market disruption, the liquidity facility can and would be drawn upon to repay maturing ABCP on a timely basis."
The Gianatasio piece also asks, "Q. In highlighting the advantages of ABCP over other cash investments, you mentioned the diversification benefits and the historical yield advantage. Are there any other reasons to include ABCP in a cash portfolio?" It explains, "A. For the managers of cash portfolios, the flexibility inherent in ABCP is an important benefit. ABCP is typically issued with maturities ranging from overnight to 270 days. This flexibility allows portfolio managers to customize their exposures to fit their overall portfolio construction strategy. Another important benefit is transparency. Unlike the holders of unsecured investments, ABCP investors can clearly see the assets they own within the conduit. Investors receive detailed monthly reporting that allows them to track portfolio performance and identify risks in a timely manner."
Finally, BofA Global says, "Q: Given the potential benefits ABCP can provide, do you suggest that cash investors include it in their portfolios? A. We believe clients for whom ABCP is appropriate should consider adding it to their portfolios. We believe that the ABCP market will continue to play an important role in the cash investment management business for years to come. ABCP is an important source of funding for banks and their clients, and ABCP investors benefit from a diversified, high quality, secured investment option that typically offers a yield pickup relative to the yield offered by unsecured CP."
