Asset-Backed Commercial Paper – ABCP
An asset-backed commercial paper program refers to a short-term debt backed by collateral. It is an investment vehicle that is short-term with a maturity period of between 90 and 270 days. Those corporations with high credit ratings issue a commercial paper without any collateral.
A Little More on What is Asset-Backed Commercial Paper – ABCP
Companies use asset-backed commercial paper to the needed capital immediately. Firms issue commercial paper that amounts to $100,000 and above. ABCPs and commercial paper are one of the many money market instruments. You invest in ABCPs the moment you purchase money market funds.
ABCPs are different from commercial paper because they are backed collateral. Collateral here means that the future payments are made on credit cards, auto loans, and invoices. Companies can use ABCPs to borrow money in return for these future expected payments. Long-term debts such as mortgages are for backing ABCPs.
The interest payment that ABCP investors get comes from the pool of assets used to back the security, such as car loans. Upon maturity of the collateralized papers, investors are given a principal payment generated from collections of the asset credit, new ABCP issuance, or liquidity facility of credit.
Advantages of ABCPs
ABCPS ensures that there is liquidity in the economy. They enable corporations and banks to sell off debts. By doing so, they release more capital to the public for investing and loaning.
Compared to long-term corporate bonds, ABCPs are less risky because they are short-term. The short period of time does not give room for risk. Before a risk builds up, it would have reached maturity. Companies that issue the ABCP are those that are well established. Their chances of defaulting in a short period are unlikely.
Disadvantages of ABCPs
The ABCPs’ downside was partly because of the SPV structure. Now, since the SPV and the bank existed as separate firms, they received protection from the default of others. This move resulted in a false sense of security amongst banks. The banks stopped adhering to their usual strict standards.
In addition, there was no collection of loans by banks on their due date. Instead, there was the selling of the underlying loans to the secondary market and became other investors’ problems. It is the reason why banks refused to adhere to their usual strict standards.
Reference for “Asset-Backed Commercial Paper – ABCP”
Academic research on “Asset-Backed Commercial Paper – ABCP”
The evolution of a financial crisis: Collapse of the asset‐backed commercial paper market, Covitz, D., Liang, N., & Suarez, G. A. (2013). The evolution of a financial crisis: Collapse of the asset‐backed commercial paper market. The Journal of Finance, 68(3), 815-848. This paper documents “runs” on asset‐backed commercial paper (ABCP) programs in 2007. We find that one‐third of programs experienced a run within weeks of the onset of the ABCP crisis and that runs, as well as yields and maturities for new issues, were related to program‐level and macro‐financial risks. These findings are consistent with the asymmetric information framework used to explain banking panics, have implications for commercial paper investors’ degree of risk intolerance, and inform empirical predictions of recent papers on dynamic coordination failures.
Do global banks spread global imbalances? Asset–backed commercial paper during the financial crisis of 2007–09, Acharya, V. V., & Schnabl, P. (2010). Do global banks spread global imbalances? Asset-backed commercial paper during the financial crisis of 2007–09. IMF Economic Review, 58(1), 37-73. The global imbalance explanation of the financial crisis of 2007–09 suggests that demand for riskless assets from countries with current account surpluses created fragility in countries with current account deficits, most notably in the United States. This paper examines this explanation by analyzing the geography of asset-backed commercial paper (ABCP) conduits set up by large commercial banks. The paper shows that banks in surplus countries as well as banks in deficit countries manufactured riskless assets, totaling over $1.2 trillion, by selling short-term ABCP to risk-averse investors, predominantly U.S. money market funds, and investing the proceeds primarily in long-term U.S. assets. As negative information about U.S. assets became apparent in August 2007, banks in both surplus and deficit countries experienced difficulties in rolling over ABCP and as a result suffered significant losses. The paper concludes that global banking flows, rather than global imbalances, determined the geography of the financial crisis.
How effective were the Federal Reserve emergency liquidity facilities? Evidence from the asset‐backed commercial paper money market mutual fund liquidity facility, Duygan‐Bump, B., Parkinson, P., Rosengren, E., Suarez, G. A., & Willen, P. (2013). How effective were the Federal Reserve emergency liquidity facilities? Evidence from the asset‐backed commercial paper money market mutual fund liquidity facility. The Journal of Finance, 68(2), 715-737. The events following Lehman’s failure in 2008 and the current turmoil emanating from Europe highlight the structural vulnerabilities of short‐term credit markets and the role of central banks as back‐stop liquidity providers. The Federal Reserve’s response to financial disruptions in the United States importantly included the creation of liquidity facilities. Using a differences‐in‐differences approach, we evaluate one of the most unusual of these interventions—the Asset‐Backed Commercial Paper Money Market Mutual Fund Liquidity Facility. We find that this facility helped stabilize asset outflows from money market funds and reduced asset‐backed commercial paper yields significantly.
Altering Investment Decisions to Manage Financial Reporting Outcomes: Asset‐Backed Commercial Paper Conduits and FIN 46, Bens, D. A., & Monahan, S. J. (2008). Altering Investment Decisions to Manage Financial Reporting Outcomes: Asset‐Backed Commercial Paper Conduits and FIN 46. Journal of Accounting Research, 46(5), 1017-1055. We evaluate the manner in which sponsors of highly leveraged asset‐backed commercial paper (ABCP) conduits responded to Financial Accounting Standards Board Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities an Interpretation of ARB No. 51, and its Canadian counterpart Accounting Standards Board of Accounting Guideline 15 (AcG‐15), Consolidation of Variable Interest Entities. By matching commercial paper investors with corporations seeking liquidity, ABCP sponsors facilitate a significant amount of short‐term, securitized financing in the United States. FIN 46 and AcG‐15 require sponsors to consolidate their ABCP conduits with their financial statements. We demonstrate that the volume of ABCP began to decline when FIN 46 was first proposed, and that this decline is primarily attributable to a reduction in North American banks’ sponsorship of ABCP. We also demonstrate that North American banks entered into costly restructuring arrangements to avoid having to consolidate their conduits per the new accounting standards. Our results suggest that, in certain settings, accounting standards appear to have real effects on investment activity and product‐market competition.
How do global banks scramble for liquidity? Evidence from the asset–backed commercial paper freeze of 2007, Acharya, V. V., Afonso, G., & Kovner, A. (2017). How do global banks scramble for liquidity? Evidence from the asset-backed commercial paper freeze of 2007. Journal of Financial Intermediation, 30, 1-34. We investigate how banks scrambled for liquidity following the asset-backed commercial paper (ABCP) market freeze of August 2007 and its implications for corporate borrowing. Commercial banks in the United States raised dollar deposits and took advances from Federal Home Loan Banks (FHLBs), while foreign banks had limited access to such alternative dollar funding. Relative to before the ABCP freeze and relative to their non-dollar lending, foreign banks with ABCP exposure charged higher interest rates to corporations for dollar-denominated syndicated loans. The results point to a funding risk manifesting as currency shortages for banks engaged in maturity transformation in foreign countries.
How effective were the federal reserve emergency liquidity facilities? evidence from the asset–backed commercial paper money market mutual fund liquidity facility, Duygan-Bump, B., Parkinson, P. M., Rosengren, E. S., Suarez, G., & Willen, P. (2012). How effective were the federal reserve emergency liquidity facilities? evidence from the asset-backed commercial paper money market mutual fund liquidity facility. The events following Lehman’s failure in 2008 and the current turmoil emanating from Europe highlight the structural vulnerabilities of short-term credit markets and the role of central banks as back-stop liquidity providers to financial markets. The Federal Reserve’s response to financial disruptions in the United States importantly included creating liquidity facilities. Using unique micro datasets and a differences-in-differences approach, we evaluate one of the most unusual of these interventions — the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility. Our findings indicate that this facility helped stabilize asset outflows from money market funds and reduced asset-backed commercial paper yields significantly.