Deals: Picaros Funding, Ormond Quay, North Sea Funding
Authorized amounts: e5 billion, e5 billion, e10 billion
Sponsors: KBC Financial Products UK, Sachsen LB Europe, ABN Amro
Dates: June-July 2004
A Moody?s report last month indicated that asset-backed commercial paper (ABCP) volumes in Europe, the Middle East and Africa fell slightly in the second quarter of 2004. The amount of ABCP funded by EMEA conduits fell to $103 billion in April from $106 billion three months before as spreads tightened and competition for AAA rated securities from CDO squared deals and structured investment vehicles rose, although the pipeline remains strong.
A slowdown was overdue. The ABCP market has grown quickly, stretching liquidity lines. ?There have been liquidity issues for three or four years,? says Kevin Ingram, partner at law firm Clifford Chance. ?Internal managers at the banks have realized that ABCP isn?t a capital-free or risk-free product. These programmes are huge.? Concerns that Basle II would increase risk weightings for undrawn liquidity facilities exacerbated these worries.
So sponsors are taking the simple idea of buying long-term assets with short-term funding and creating innovative new deals to fund new assets and tap non-bank sources of liquidity. Three recent deals illustrate this trend.
Picaros Funding, structured and arranged by the treasury desk of KBC Financial Products UK, is the first European synthetic total-return swap ABCP programme.
With a total-return swap structure, the credit derivative references assets that are not held by the issuer. Picaros can therefore be used to fund illiquid assets or assets that are difficult to trade and could not be funded by a conventional cash CP conduit, such as hedge fund assets or fund-of-funds derivatives.
With KBC Bank guaranteeing the swap, there is no need for a formal liquidity line. If KBC Bank were downgraded, Picaros could arrange a third-party guarantee or take cash assets onto its balance sheet, effectively becoming a CP hybrid.
Picaros is bankruptcy remote and achieved an A-1/P-1 rating. The swap guarantee ranks with KBC Bank?s senior unsecured creditors. So although investors in Picaros are not secured creditors, the low counterparty risk enables Picaros to fund at Libor or Libor minus one to two basis points. In a cash deal, perceived asset quality can add to funding costs. In Picaros, asset quality is immaterial.
German Landesbank Sachsen LB made its ABCP debut in July with its Ormond Quay arbitrage conduit. Its Dublin subsidiary, Sachsen LB Europe, is issuing ABCP to buy highly rated asset-backed securities. But Ormond Quay isn?t restricted to issuing ABCP. It has also entered into repo agreements as an alternative funding source.
?On arbitrage conduits, there is much more scope to deal with liquidity issues,? says Clifford Chance?s Ingram, whose firm gave legal advice on the deal. ?Banks now see them as a product to be used as part of their trading operations. Using a repo programme brings that closer.? Ormond Quay has a Prime-1 rating from Moody?s.
Despite tight spreads, there is still money to be made in the arbitrage business. While Sachsen LB was venturing into the ABCP market for the first time, ABN Amro, the second-largest ABCP sponsor globally in 2003 according to Moody?s, was launching its first debt securities arbitrage conduit, North Sea Funding. By extending its ABCP activities into securities arbitrage, ABN Amro can offer its clients arbitrage opportunities to finance securities purchases.
Under North Sea Funding, different purchasing vehicles buy securities for their own portfolio. The life of each purchaser divides into two phases. In the first phase, the purchaser cannot issue notes subordinated to the ABCP, and credit enhancement takes the form of a loan agreement with the sponsor. The size of the loan is calculated using the Moody?s standard matrix. In the second phase, purchasers can issue subordinated notes subject to some ratings constraints. They use CDO-style analysis to work out the level of credit enhancement required.
?As a large sponsor, ABN wanted to make the conduit more stable,? says Mayer, Brown, Rowe & Maw partner Mark Nicolaides, ABN Amro?s lead lawyer on the deal. ?Even if the composition of the asset pool can vary, it wants to keep funding at good rates.?
NSF has funding flexibility, both through repo facilities and extendable notes. ?ABN Amro has built some liquidity into itself,? says Nicolaides. NSF can also issue floating-rate ABCP.
In another innovation, the conduit documentation contains provisions for the off-balance-sheet treatment under both US GAAP and, more unusually, IAS.
NSF was structured by Gerwin Scharmann, who joined ABN as head of securities arbitrage in August last year from Bankgesellschaft Berlin. It closed on July 2.
