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Confidence Creeping Back Into CP Sector
Asset Backed Alert, Harrison Scott Publications Inc. (October 17, 2008)
The asset-backed commercial paper market showed signs of recovery this week, as sweeping government efforts to bolster financial markets made investors more comfortable with longer-term conduit issues.
It also helped that Lehman Brothers' credit-default swap obligations were settled via an Oct. 10 auction, ending a situation that had many institutions with exposure to the bank dumping investments in favor of hard cash.
The confluence of factors caused yields on 30-day conduit paper to fall below 4.4% this week, after spiking to a record 5% on Oct. 13 - offering solid evidence that investors who shunned the market in recent weeks are now trickling back.
The uptick in demand is also creating some hope for the battered term-securitization business, as the conventional wisdom is that short-term markets are first to recover from liquidity crunches. Industry insiders also think the term market will improve as the federal government's Troubled Asset Relief Program (TARP) kicks into gear.
However, the consensus is that a further rebound on the commercial-paper side will be necessary before longer-term asset- and mortgage-backed issues follow suit. For now, the market for term deals remains in a funk. Trading this week was light to nonexistent, as prices weakened or hovered near record lows.
Still, the developments for commercial-paper players are encouraging. "It seems that there's some thawing," said Debbie Cunningham, who oversees taxable money-market funds at Federated Investors, a $333 billion firm in Pittsburgh. Cunningham added that she saw growing interest this week in a larger variety of conduit issues, including 30-day, 3-month and 6-month paper.
Demand for offerings with those durations had dried up last month, as money-market funds braced for widespread withdrawals after Lehman-related losses caused Reserve Management's Reserve Primary Fund to "break the buck," or allow its share price to fall below $1. Investors also became nervous about parking capital for more than a day with any financial institution that might fail.
As a result, they moved their capital into cash equivalents, such as overnight paper. And interest rates swelled on longer-term issues.
This week's falling yields are partly the result of multi-pronged government efforts to restore liquidity to the commercial-paper market, suggesting that the pattern will continue. They include the implementation of a $50 billion U.S. Treasury Department program to insure money funds and a move that allows financial institutions to use asset-backed CP as collateral for low-cost loans from the Federal Reserve's discount window. The Fed also plans to begin buying commercial paper directly from issuers on Oct. 27.
An example of how the efforts are working: State Street's money-management unit boosted its investments in asset-backed commercial paper by $212 million in the quarter ended Sept. 30, to $7.8 billion. About $1.6 billion of its holdings would be eligible for the Fed's direct-purchase program, which will only take in top-rated paper with 3-month terms.
Some of the market rebound also can be traced to the government's decision this week to invest $250 billion directly in banks - a measure that alleviates concerns about potential short-term failures by trading partners. Nonetheless, liquidity is far from restored.
Yields on conduit paper of all durations remain well above pre-credit-crunch levels, which often saw offerings sell below Libor. Use of the discount-window program has slipped slightly as well, to $123 billion on Oct. 15 from $140 billion the week before. "A lot of the big buyers of [asset-backed CP] are all just husbanding their cash," explained one trader at a broker-dealer. He said threats of redemption requests mean many fund managers must still stick with the shortest-term deals instead of seeking larger returns further out on the yield curve. "The yield is meaningless in this market."
The longer-term outlook remains more positive though, with the Fed gearing up to buy paper and the Treasury taking steps to purchase troubled mortgage-backed securities from banks under TARP.
"It's important to be patient," said Adolfo Laurenti, senior economist at Chicago financial-services firm Mesirow Financial. "I don't think that we can restore liquidity to these markets overnight."
Guy LeBas, an analyst at Janney Montgomery Scott in Philadelphia, echoed Laurenti's sentiments. "It's really just a matter of time," he said. "I think a lot of it is simply a slow process."
That reality was reflected in the market for term asset- and mortgage-backed securities, where trading is still sparse and wide spreads remain the rule. "It's become a very frustrating market," said one buysider.
After bouncing up to about 70 cents on the dollar last week on TARP-related optimism, issues of 5- to 6-year securities backed by option adjustable-rate mortgages have slipped 2-3 cents, the investor said.
Bonds backed by credit-card receivables were trading at 200-500 bp over Libor and swaps, depending on the issuers and deal durations. That's unchanged from last week, when spreads on non-mortgage transactions had crept out a bit. "[Spreads] stopped widening, that's about it," a trader at one investment bank said.
There was no immediate word of spread movement after Citigroup and Merrill Lynch announced heavy credit-crunch-related losses yesterday. v