Gloomy Mood Overtakes Conduit Industry
Could the commercial-paper conduit industry vanish in 2010?
While the thought has been in the backs of many market players' minds for years, it has lately come to be seen as less of an extreme view and more of a real possibility. That's because there's a growing sense that nothing will be done to temper the effects of the Financial Accounting Standards Board's pending FAS 166 and 167 rules.
"We may be going to zero," one investment-bank staffer said, referring to the volume of conduit paper in the hands of investors.
Ever since FASB started work on the earliest precursors to its new accounting guidelines six years ago, industry pessimists have warned of a chilling effect on the market. Now set to take effect Jan 1, the rules would end off-balance-sheet treatment for assets securitized by banks and certain vehicles they run - including conduits.
The upshot would be a vast increase in the amounts of reserve capital those institutions have to hold, which could drive up conduit-related funding costs to uneconomical levels virtually across the board.
Many securitization specialists were until recently holding out hope for a reprieve. It's ultimately up to the FDIC and Federal Reserve to dictate how capital should be set aside against on-balance-sheet conduit assets, and market professionals have been pushing hard for relaxed or at least clarified rules.
It wasn't until now, with the implementation date in sight, that even previously bullish players have started losing hope. "There is a fair probability that there will be little change to what has been proposed," said one source who has been involved in the lobbying efforts.
Some are also sounding alarms that the effects could reverberate beyond the asset-backed commercial paper market, as a range of bank clients lose access to funding. "If the regulators don't give regulatory relief for on-balance-sheet conduit exposure, it will further screw up the economy," one conduit executive said.
Last week, Citigroup, Wells Fargo and J.P. Morgan asked federal authorities for a three-year reprieve from additional capital requirements stemming from the FASB guidelines. The American Securitization Forum previously asked for a six-month delay.
Already, the FASB-related fears are contributing to a pre-existing decline in the volume of conduit paper outstanding. Of course, general economic and credit-market woes are also having a tremendous dampening effect on the sector. But for now, the accounting changes have taken over as the number-one worry.
The overall volume of outstanding conduit securities has been falling sharply ever since the credit crisis began, from a peak of $1.2 trillion in August 2007 to $500 billion last month. That figure now stands at $482 billion.
In part, the latest declines reflect an approach in which many administrators have been allowing the sizes of their vehicles to drift lower in anticipation of the FASB rules. And without some resolution of the issue, they're likely to continue with that tactic. That goes against a sentiment many held just a few months ago, when a market rebound seemed possible. "There's a lot of uncertainty out there with respect to possible changes in the accounting and regulatory capital standards," Moody's senior vice president Everett Rutan said. "That will likely cause people to hesitate before embarking on a major expansion of their conduit business."
Data tracked by Moody's points toward further weakness. Specifically, the conduit utilization rate - the average proportion of a conduit facility a borrower actually taps -has fallen 10-15 percentage points since early 2007 to the low-50% range. The fact that bank clients aren't drawing on their lines at a time when credit is hard to come by shows that they either have fewer assets to finance or are finding more appealing sources of funding, Rutan said.
One company that appears to have found cheaper borrowing costs outside the conduit market is Rite Aid. On Oct. 19, the drug-store chain said it would use a combination of proceeds from unsecured bonds, a term loan and a revolving credit facility to retire a $475 million conduit line.
Among the market's 20 largest conduits, most were smaller during the second quarter of 2009 than during the final three months of 2008, according to the latest data available from Moody's. During the same periods, those vehicles' combined average outstandings totaled $230.7 billion, down from $265.7 billion.
The most notable exceptions were RBS' market-leading Amstel Funding, and Citi's Dakota. Amstel's increase, however, is a somewhat of a fluke. The vehicle issues in euros, which have been gaining against the dollar - causing its average size in dollars to grow by nearly $600 million even though its actual obligations remained flat at €13.1 billion.
Even without that boost, however, Amstel would be the world's largest conduit - ahead of Lloyds Banking's Cancara Asset Securitisation, at $15.4 billion
Dakota, which funds credit-card receivables for Citi, grew from an average of $9.9 billion in the fourth quarter to $11 billion during the March-June stretch. The expansion likely reflected efforts by Citi to warehouse assets for term deals, which it began issuing with increasing frequency during the second quarter.
There were also four additions to the top-20 list, including the U.S. Department of Education's Straight-A Funding. That entity was set up this year to help relieve education lenders of older credits that would otherwise be difficult to fund.
The other additions - Citi's CRC Funding, HSBC's Mazarin Funding and State Street's Clipper Receivables - have all been up and running for a while. They have the dubious distinction of joining the biggest-conduit club because they shrank less quickly than Citi's Charta, J.P. Morgan's Falcon Asset Securitization, Liberty Hampshire's Crown Point Capital and RBS' Thames No. 1.
Among the 20 most active administrators, there were few changes. Straight-A's presence earned a spot for joint administrators Bank of New York and BMO Capital, while Citi remained the most active player in the field, followed by RBS.
Meanwhile, the overall theme remains the same: "The outstandings are all drifting down. They're just drifting down at different rates," Rutan said.
The only possible opportunity for a reversal at this point appears to be intervention from the FDIC or the Fed, at which point the economy might re-emerge as the biggest factor driving issuance.