What Is an Asset-Backed Commercial Paper (ABCP)?
Let me explain to you what an asset-backed commercial paper, or ABCP, really is. It's a short-term investment vehicle with a maturity date that typically falls between 90 and 270 days. Usually, a bank or another financial institution issues this security directly. These notes are backed by the company's physical assets, such as trade receivables. Companies turn to ABCP to meet their short-term financing needs.
Key Takeaways
You need to know that an asset-backed commercial paper (ABCP) serves as a short-term investment with a maturity of no more than 270 days. Banks, financial institutions, or large corporations issue these ABCPs, which are notes secured by collateral. That collateral often includes the corporation's expected future payments or receivables. These receivables could come from payments on loans the corporation has issued, like auto loans, credit card debt, student loans, or residential mortgages.
Understanding Asset-Backed Commercial Paper (ABCP)
I want to dive deeper into how ABCP works. It's a short-term money-market security issued by a special purpose vehicle (SPV) or conduit, set up by a sponsoring financial institution. The maturity is capped at 270 days, and it's issued either on an interest-bearing basis or at a discount.
The note is backed by the corporation's collateral, which could include future payments from credit cards, auto loans, student loans, and collateralized debt obligations (CDOs). We collectively call these expected payments accounts receivables. The proceeds from issuing ABCP are mainly used to acquire interests in various assets, either by purchasing them outright or through secured lending.
Important Note
Here's something crucial: a company can create an ABCP from any type of asset-backed security, including subprime mortgages. These are high-risk mortgages that played a major role in triggering the 2008 financial crisis.
Commercial Paper (CP) vs. Asset-Backed Commercial Paper (ABCP)
Let me clarify the difference between commercial paper (CP) and asset-backed commercial paper (ABCP) for you. The main distinction is that regular commercial paper isn't backed by assets. CP is a money market security that large corporations issue to raise funds for short-term obligations. It has a fixed maturity under one year and functions as a promissory note supported only by the issuing company's high credit rating.
Investors buy CP at a discount to its face value and get repaid the full amount at maturity. Since standard CP lacks collateral, only companies with top credit ratings from recognized agencies can sell it at a reasonable price. ABCP, on the other hand, is a type of CP that's backed by other financial assets.
If a company or bank wants to boost liquidity, it might sell receivables to an SPV or conduit, which then issues them as ABCP to investors. This ABCP is secured by the expected cash inflows from those receivables. As the receivables are collected, the originators pass the funds to the conduit, which then disburses them to the ABCP noteholders.
ABCP Interest Payments
During the investment's life, the sponsoring financial institution that established the conduit monitors any developments that could impact the performance and credit quality of the SPV's assets. The sponsor ensures that ABCP investors receive their interest payments and principal at maturity.
Those interest payments come from the pool of assets backing the security, such as monthly car loan payments. When the ABCP matures, the investor gets the principal payment, funded either from collecting the credit assets, issuing new ABCP, or tapping into the credit's liquidity facility.
Special Considerations
While most ABCP programs primarily issue commercial paper as their main liability, they've diversified funding sources recently to include medium-term notes (MTNs), extendible commercial paper, and subordinated debt for credit enhancement.
One key concern with ABCPs and similar investments is liquidity risk. If the market value of the underlying assets drops, the safety and value of the ABCP could suffer as well. You should understand the makeup of those underlying assets and how economic downturns might affect their value. In some cases, investors might not be able to sell quickly to cut losses, which is one of the risks tied to asset-backed commercial paper.
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