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Conduit Players Pray for October Rebound
Asset Backed Alert, Harrison Scott Publications Inc. (September 14, 2007)
Issuers of asset-backed commercial paper hope to start digging their way out of the market's oppressive liquidity crunch next month.
The thinking, at least among the optimists, is that money-market funds that suddenly began snubbing new conduit issues over the past month will eventually have so much cash to put to work that they'll have no choice but to return. Indeed, the amount of capital parked in money-market accounts has been swelling in recent weeks, driven largely by additions from institutional investors.
If and when some of those funds begin streaming back into conduits, the managers will be returning to a sector that in many ways is devolving into what it was in its early days - a landscape ruled by multi-seller vehicles with full liquidity backstops. It was only since the mid-1990s that single-seller entities with newfangled forms of liquidity and structured investment vehicles began to proliferate, helping the market swell to previously unimaginable levels.
"In a few short months, everything has come tumbling down," one banker said. Like most industry professionals, he believes that growth will return to the once-booming business once the current liquidity crisis is over.
For the time being, conduit operators will have to wait and see if the recent growth among money funds will be reversed by a slew of redemptions from those accounts at the end of the third quarter. If it isn't, many are betting that the managers - which buy the bulk of conduit issues - will be emboldened to resume investing in their offerings.
"There are only so many T-bills they can buy," one conduit banker said, referring to another popular type of quarry for money funds. Since the subprime mortgage crisis indirectly caused the bottom to fall out of the conduit market in early August, such investors have diverted huge sums of capital into U.S. Treasury bonds or other cash equivalents.
Conduit operators have already had their hopes of a recovery dashed once. Heading into this month, some speculated that commercial-paper buyers would return in force. That didn't happen, and the amount of U.S. asset-backed commercial paper in the hands of investors subsequently dropped to $945 billion this week, from a record high of $1.2 trillion on Aug. 8, according to the Federal Reserve Board. Some $14 billion of the decline came this week alone (see Market Monitor on Page 15).
Even if the bulk of investors eventually come back on line, most will probably avoid offerings from vehicles with anything but plain-vanilla liquidity support. That means a much smaller presence for SIVs and so-called extendible conduits.
Instead of employing traditional liquidity support, SIVs rely on frequent assessments of their holdings' market values - a structure that has proved unreliable in certain cases. As the fallout from the collapse of the subprime-mortgage business spread in recent weeks, managers of the securities-arbitrage vehicles found it difficult to nail down accurate values for their structured-product holdings. Many have since moved to liquidate their assets, in some cases taking losses in the process.
Extendible conduits, meanwhile, substitute an ability to delay the terms of their issues if funds are unavailable to repay investors at maturity. Such vehicles became especially popular among the single-seller set in recent years, as operators sought to cut back on the fees they have to pay to traditional liquidity suppliers.
But investor demand for extendible paper hinged on a key expectation - that the payment delays would never actually occur.
The extendible-CP market got upended when buysider nervousness sapped investor demand for all types of structured products, rendering some of the vehicles unable to roll over paper that was coming due. That set off a chain reaction, as the conduits extended for the first time ever and what was left of their investor base headed for the hills.
Broadhollow Funding, an extendible conduit run by American Home Mortgage, became the first to delay payments on Aug. 6. The Irving, Texas, lender, which has since filed for Chapter 11 bankruptcy protection, was scheduled to sell Broadhollow's $1.6 billion mortgage portfolio this week. However, it postponed the auction at the last minute for undisclosed reasons.
Conduits set up for securities-arbitrage purposes, meanwhile, are expected to survive. That's especially true of those that benefit from traditional liquidity facilities from affiliated banks.
Dealers also report that trading of traditional multi-seller conduit paper improved slightly this week. Word has it one conduit sponsor even managed to sell $1 billion of six-month paper, although still-nervous buyers tend to be seeking safety in shorter-dated product. In fact, well over half of the asset-backed commercial paper that was placed in recent days had overnight terms.
The values of those issues remained volatile as well, after plummeting last month. Top-tier conduit paper is now changing hands at spreads of Libor flat to 60 bp over Libor. Until late July, such offerings usually traded within a tight band right around the benchmark.
"I don't think we're out of the woods yet," one industry specialist said.