Friday, 28 December 2007

ABCP market continues to slide

Asset backed Commercial Paper outstanding declined $15.9 billion in the week to December 26th. As you can see from the chart above ABCP outstanding has declined to it's lowest point in a little over 2 years, which is all the data the Fed provides on it's website.

From it's high in August the ABCP market has shed -37.4%. So what? I hear you say, you report this every week. Well, just in case you've forgotten here is a good article from the Financial Times written over a month ago that reminds us why the decline in ABCP is important, from the FT:

Banks bear the strain of short-term debt market troubles

There is a big reason why the asset-backed commercial paper market has garnered so much interest in recent weeks.

It is not simply because the volume of this short-term debt in issue has shrunk so dramatically, nor is it because millions of ordinary savers have put their trust in supposedly safe money market funds, which turned out to have large exposure to this riskier paper.

The real importance of this market is that since the end of 2004, it has been the ultimate source of the flood of cheap money that has gushed through global debt markets and helped to drive growth in asset prices and the economy.

It has been a major contributing factor to the volume of new lending business that banks around the world have been able to generate over the past three years.

But now that it has so spectacularly gone into reverse it is causing significant balance sheet discomfort to many of those same banks, because it amounts to a sudden and totally unexpected growth in lending.

Along with subprime mortgage-related write-offs and the backlog loans to private equity buy-outs, it is also helping to cause significant capital constraints, which limit the amount of planned new lending that banks can make to help keep western economies growing.

According to Kit Juckes, head of debt markets research at Royal Bank of Scotland, the impact of this is already visible in evidence such as the recent European Central Bank loan officers survey, where the general feedback was an intention to tighten lending conditions across the board.

The reason is that banks provide lending facilities to their conduits and offbalance sheet entities such as structured investment vehicles, both of which use cheap, short-term funding to finance investments in longer-term higher yielding securities or lending activities. These facilities can be called on at very short notice to fund SIVs and conduits when investors no longer want ABCP.

The ABCP market has shrunk by more than $330bn, or about 30 per cent, since its peak of about $1,190bn in July, according to the Federal Reserve and, to a great degree, banks have had to step into the breach.

"Banks have replaced ABCP and seen committed lending facilities drawn down," Mr Juckes says. "The result is astonishingly strong lending growth for the banks - lending that was unplanned."

The easiest place to see the real effects of the impact on banks is in the US, where quarterly reporting and the demands to file detailed financial statements with the Securities and Exchange Commission brings a level of transparency that European and UK banks are able to avoid.

Citigroup, for example, saw a third quarter increase in funding commitments for its conduits and SIVs of $16bn to $72bn, though it will not disclose how much of this is actually drawn.

Such an amount may be tiny compared with the total size of the bank's balance sheet, which is almost $2,300bn, but is far more significant in the context of Citi's net new lending to consumers worldwide from its balance sheet over the same quarter, which was about $20bn.

JPMorgan Chase, another big US player in the world of conduits, saw the amounts drawn on its liquidity facilities jump $12bn to $65bn in the same period.

Bank of America saw its exposure to off-balance sheet vehicles jump from $47bn to $71bn during the first nine months of the year.

However, BoA also provides an example of another route by which banks have been forced to tackle the ABCP problem, having pledged $600m to support money market funds it controls. The funds face potential losses due to their investments in ABCP. ...

The resulting strain on banks' balance sheets has also contributed to elevated money market rates. Yesterday, the two-month and three-month dollar London interbank offered rate set above 4.90 per cent, the highest level since late October.

The implications for financial companies is clear, stretched balance sheets, tighter lending standards and a higher cost of funding mean lower margins and reduced profits. Expect earnings revisions to continue well into 2008.