Extendibles face extinction
Just $30 billion of X-notes have been issued since the financial crisis.
Before Lehman’s bankruptcy the 2a7 funds used to solve their maturity mismatch problems in the extendible note (X-note) market. From 2005 to 2007 yearly issuance of X-notes topped $100 billion – most of which was gobbled up by money market funds. But just $30 billion of X-notes have been issued since the financial crisis. After Lehman’s collapse many investors put them but the notes proved difficult to trade in their extended form. Now the new regulations could be the death knell for them in 2a7 funds. "It will be very difficult for 2a7 funds to hold significant size in X-notes now," says Christopher Conetta, managing director and head of global commercial paper at Barclays Capital. "Traditional X-notes have a 13-month initial maturity with a five- or six-year legal final. From the US money market regulatory perspective it never rolls down the curve – it is always 10 to 13 months from maturity. The product will therefore struggle to exist." This is largely due to the new 2a7 requirement for a maximum 120-day WAL.
But X-notes are embedded into the short-term market. Banks are now calling them evergreen products, which run from 120 days down to 90 days and back up to 120 days. However, their days as a stalwart of the 2a7 money market seem to be over and the funds are turning to puttables as a less than perfect replacement. But this is very much dependent on the issuers’ willingness and need to issue. "From a liability management perspective a puttable product is in no way as attractive to an issuer as an X-note," says Conetta. "However the issuer is making the bet that as long as the note is not put, the blended coupons over a year will be more attractive than it could achieve if it issued a one-year bullet floater."
from the archive:
Bank liquidity crisis: They were extendible
The second half of 2007 was the most challenging period bank treasurers have ever faced. They will all be hoping that liquidity is back to normal by the middle of 2008. But many bank issuers face a looming, unexpected and until now unnoticed drain on their funding which will happen, an unlucky 13 months after the credit crunch hit. Alex Chambers reports on the $245 billion funding hole that the extendible note market has created.
"Goldman has also brought some innovation to the market. It introduced what it calls extendible commercial notes."