September 4, 2007 10:34 pm

Asset-backed commercial paper shunned

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The continued upward pressure on money market rates in the US shows how investors are spurning the asset-backed commercial paper market, forcing financial institutions to scramble for alternative sources of funding.

During the past three weeks, the size of the ABCP market has shrunk nearly 16 per cent or about $200bn to just less than $1,000bn, according to Federal Reserve data.

While the broader commercial paper market has shrunk, the asset-backed area has borne the brunt of risk aversion. This has forced ABCP issuers to tap bank credit lines and seek other sources of funding.

Ted Wieseman, economist at Morgan Stanley, said banks “are uncertain about how many ABCP-related assets they will have to bring on to their balance sheets in the months ahead”.

Such concerns have pushed dollar, euro and sterling Libor higher in recent days. “Banks are unwilling to place longer term funds in the interbank market that would tie up balance sheet room that might be needed for customer obligations,” Mr Wieseman added.

On Tuesday, the overnight ABCP top tier rate in the US was being quoted by the interbank market at 6.20 per cent – the highest it is has been during the current turmoil and up from 5.29 per cent a month ago.

The overnight rate has traded above 6 per cent since mid-August and investors fear upward pressure will remain in place for some time.

“There remains a substantial risk that upwards of 85 to 90 per cent of the trillion-dollar ABCP market may need to roll over on a very short-term or even overnight basis [the historical average is between 60 and 65 per cent], which could prove seriously destabilising for the corporate sector and, ultimately, the economy,” said Deutsche Bank. A significant portion of the asset-backed commercial property market has been tied to mortgages, about $300bn.

Tony Crescenzi, strategist at Miller Tabak, said: “It would be rational to expect the asset-backed commercial paper market to shrink by as much as $300bn.”

Such a move would reflect a “purge” of risky assets that should prevent a “spillover into the broader commercial paper market where most issuers are top-notch credits,” said Mr Crescenzi.

Many institutions in the US and Europe have raised short-term funding using home loans as collateral, which explains why money market rates on both sides of the Altantic have been moving higher.

Deutsche Bank estimates that at least $600bn, or 28 per cent, of the US corporate ABCP market is held by foreign institutions.

The bank believes the percentage of foreign exposure to corporate mortgage-backed ABCP is much higher, at almost 39 per cent.

Analysts fear that, should institutions find it increasingly difficult to roll over their ABCP exposures, even on an overnight basis, the pressure to find other sources of financing could impair the entire financial system.

The Fed this month clarified how banks could use ABCP as collateral to borrow at its discount window following inquiries from financial institutions.

But, late last week, money market and ABCP rates moved higher. Dealers noted banks were reluctant to use the discount window with asset-backed paper.

Dealers said posting ABCP as collateral could entail receiving an amount of funding from the Fed, possibly as low as 60 per cent of the total collateral.

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