In wake of sub prime crisis, we have been continuously reading – “Asset Backed Commercial Paper’s are still shrinking..; Interest rates on ABCP’s are rising ; FED provides auction window to banks for their ABCP’s.. etc etc but what are really Asset Backed Commercial Paper’s.
So here’s the fundamentals on ABCP: Commercial Papers are generally short term unsecured commercial debt securities issued at high interest rates. However, if the same instrument is backed by a steady flow of income from an existing ‘asset’ it makes the product more secure and provide an avenue to the issuer raise debt at lower cost.
The ABCP’s are primarily issued by organizations to release their locked ‘receivables’. For example, if a company has provided a short term loan, it can protect itself by setting up a conduit (a special purpose vehicle). This SPV will purchase the receivable and issue an ‘asset backed commercial paper’ to investors (who purchase at market determined interest rate). Thus, in bargain the originator, receives the loaned amount (from SPV) and passes the default on to the conduit. Though, it seems like just another form of ABS and or a CDO except the duration is for very short period, hence comparatively safer. Till the obligor is paying their obligation (i.e., principal and interest), investors are safe. If the obligor defaults, the conduit may default as well.
Once ABCP market was higher than $1.3trillion, now due to market collapse and rising interest rates, investor have been reluctant to invest in the product. As of 20 March data, the ABCP market has shrunk to about $800million. Almost 40% from its peak.