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Tuesday, August 14, 2007


difficulties in commerical paper

via calculated risk, it's beginning to look like the credit crunch has made mortgage-backed securities so illiquid that asset-backed commerical paper -- the stuff of money market funds -- may break down.

Coventree Inc., the Canadian finance company that went public in November, failed to sell asset-backed commercial paper to replace maturing debt because of the credit crunch caused by U.S. subprime mortgage losses.

The shares tumbled 35 percent after the company extended maturities on C$250 million ($238 million) of commercial paper and sought emergency funding for another C$700 million of debt. Toronto-based Coventree's units have about C$16 billion of asset- backed commercial paper outstanding.

``Problems that initially seemed isolated to a few U.S. subprime mortgage lenders have led to broader concerns relating to debt capital markets generally,'' including the Canadian asset- backed commercial paper market, Coventree said in a statement today.

... ``There's so much CP out there, and if one part of the market locks up, it tends to be contagious,'' said Brian Yelvington, a strategist at CreditSights Inc. in New York.

In the U.S., asset-backed commercial paper comprises about $1.15 trillion of the $2.16 trillion in commercial paper outstanding. The debt is backed by mortgages, bonds, credit card and trade receivables as well as car loans.

In the U.S., extendible notes constitute about $172.5 billion in debt outstanding, according to Moody's Investors Service. About $60 billion is backed by mortgages securities, according to New York-based Bears Stearns.

Coventree's announcement heightened worries that rising defaults on subprime loans are infecting securities across the credit markets. DBRS, a Toronto-based ratings company, said today it received notice from ``a number of'' Canadian issuers that had sought backup financing.

``It's not just Coventree,'' said Huston Loke, group managing director of Global Structured Finance at DBRS. ``We're still in the process of going through notices. When it becomes more clear, we'll have more to say.''

``If a manager is extending due to the inability to issue new CP, there is little incentive for the traditionally low-risk tolerant CP purchasers to take risk on new paper from that issuer,'' Yelvington said. ``The risk-reward usually is not high enough.''

there is risk here. some money market funds may be considerably exposed. from barron's this week:

Nevertheless, the lack of transparency for the new esoteric instruments, such as collateralized debt obligations and collateralized loan obligations, has exacerbated the current nervousness because nobody knows what they're worth, he also notes.

In that, it appears some of the problem lies with asset-backed commercial paper "conduits" and so-called structured investment vehicles. These ABCP conduits and SIVs are used to fund the purchase of assets such as trade receivables, auto loans, credit cards, whole mortgage loans, as well as securities such as corporate debt, residential mortgage-backed securities and CDOs, according to a Bear Stearns report.

The ABCP conduits and the SIVs then are able to issue high-grade commercial paper to finance these assets, which are less the prime quality. ABCP now comprises over half the $2 trillion-plus commercial paper market, up from 20% in 1998, according to MacroMavens' Stephanie Pomboy. And, money market funds own 27% of all CP outstanding, she also notes.

According to the Bear report, some $38 billion-$43 billion RMBS and CDOs could be liquidated from ABCP conduits. Got that? In other words, a load of these assets is backing ABCP and may have to be sold into a less than receptive market.

even more here from ft alphaville.

nobody close to this sector expects to see a quick solution soon. Commercial paper interest rates have not yet fallen, irrespective of central banks’ actions. In New York on Friday, they closed at their highest level for six years.

There is deep uncertain­ty about what the central banks will do next – making ABCP players even more reluctant to start issuing and trading again. “Nobody is going to handle commercial paper if they think the Fed could be about to cut rates or do something else completely unexpected overnight,” explains one.

However, the third, most pernicious problem is that it is becoming clear central banks cannot resolve the biggest problem – a lack of clarity about valuations in structured credit markets and the almost complete loss of confidence that is infecting even the biggest and most diversified of conduit-type programmes.

and from the economist:

The trouble is, the banks suspect that even worse problems may be lurking, especially in the asset-backed securities markets where most have invested heavily. This is clear from the performance of the commercial-paper market, another short-term asset class that rarely hits the headlines, where rates suddenly hit six-year highs last week. In recent years, banks have created an abundance of investment funds, known as structured investment vehicles and conduits, which finance themselves through the $2.2 trillion commercial-paper market and invest in asset-backed securities, such as mortgages. Now banks are forcing their counterparties to pay a much higher price to roll the paper over, and it is not clear how quickly central-bank injections of liquidity will ease the squeeze.

The mounting concerns about overnight interbank rates and the commercial-paper market have led many investors to argue that the Fed should cut rates to restore calm. That would follow the script from 1998 when three rate cuts between September and November helped to bring the LTCM crisis to a speedy end.

But the Fed chairman, Ben Bernanke, made clear this month that inflation was more of a concern than disorderly markets. Some fear that even if the Fed did ease monetary policy to restore order, lingering inflation fears would push up long-term rates, compounding America’s mortgage mess.

once again, it's an insolvency crisis of which one of the features is a liquidity crisis. no one knows where the bad debt is concentrated, no one wants to hazard more exposure to it, so no one buys or lends while many try to sell and borrow. but that there is a lot of bad debt -- upon which a lot of leverage is placed -- is a feature that was not present in 1998.

UPDATE: the first money market fund i've ever seen to suspend redemptions. unfortunately, sentinel is a liquidity reserve for futures and commodities traders.

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