Europeans Offsetting US Conduit Contraction

The worldwide asset-backed commercial paper market appears to be regaining forward momentum, thanks to increasing output from European banks.

According to Moody's, the world's 20 largest conduit administrators had a combined average of $391.8 billion of securities outstanding during the fourth quarter of 2010, up from $380.1 billion during the second quarter. Now, indications are that global conduit outstandings could rise throughout 2011 — following a decline that dated back to the 2007 market crash.

Europe-based conduit operators are playing a big role in the shift, particularly RBS. The bank ranked as the world's largest administrator, up from fourth six months earlier, as its average outstandings grew to $51 billion from $29.5 billion. The main reason: It began using a vehicle called Churchill Loan Asset Securitization that weighed in at an average of $23.6 billion during the final three months of last year, up from zero three months earlier.

In fact, the total for the top-20 administrators would have shrunken had it not been for Churchill.

Most other conduits that experienced rapid growth during the fourth quarter are run by European banks. Rabobank's Nieuw Amsterdam vehicle grew 76% to an average of $6.5 billion, for example, while Lloyds Banking's Argento Variable Funding was up 53% to $9 billion. “They're moving forward with their conduits, guns blazing,” one source said.

Among European institutions in the top 20 administrators, Barclays, Deutsche Bank, Lloyds and Societe Generale joined RBS in posting overall gains during the fourth quarter. BNP Paribas, Calyon, HSBC, Rabo and Royal Park Investments saw their totals decrease.

The upshot is that on average, the volume of outstanding paper from European players was up some $20 billion during the fourth quarter.

U.S. operators, meanwhile, continued an ongoing retreat from the conduit sector — even though it might not appear that way at first blush. For instance, BNY Mellon ranked as the number-two administrator with a $39.7 billion total, up from a then-market-leading $36.5 billion. And the bank was joined by Ford and Lord Securities in boosting its presence. The only U.S. players in the current top 20 to experience a fourth-quarter decline were Citigroup and State Street. And J.P. Morgan's tally remained unchanged.

But that doesn't take into account Bank of America, which fell out of the upper ranks as its outstandings shriveled to $3.5 billion from $14.8 billion. BofA has since stopped issuing asset-backed commercial paper altogether. Its withdrawal is symptomatic of moves by U.S. banks to shift funding to vehicles including receivable-purchase facilities, which finance loans in the same manner as a conduit but with the operators' own capital instead of proceeds from bond sales. Increasing capital-reserve requirements that stemmed from the Financial Accounting Standards Board's FAS 166 and 167 rules are largely to blame.

Looking forward, banks worldwide are concerned that conduits will receive less-favorable treatment under the Bank for International Settlements' planned “Basel 3” rules. However, European institutions believe local regulators will adopt versions of those guidelines that will allow commercial-paper vehicles to continue operating profitably, while U.S. banks are taking a more pessimistic view.

The shift toward more issuance from Europe likely will be evident in the Federal Reserve's tally of U.S. asset-backed commercial paper outstandings, as foreign conduit operators place more offerings with investors in the States. The Fed total has hovered around $380 billion to $400 billion since June 2010, and stood at $393.3 billion on March 2. Market players are projecting that the count could grow well beyond $400 billion as European operators become more active.

A new cousin to conduit paper backed by securities-repurchase agreements, known as collateralized CP, also could boost outstandings. Barclays and Deutsche were the first to set up vehicles to issue such debt (see article on Page 5).

It remains to be seen how the Fed will characterize the issues. For now, the rating agencies are viewing them as conduit sales.

Among conduits, the U.S. Department of Education's Straight-A funding maintained the highest average outstandings during the fourth quarter, at $37.8 billion. It offers a financing outlet for certain types of illiquid student loans.

RBS' Churchill vehicle, meanwhile, contains only commercial and consumer loans written by the bank. And there's a twist: instead of selling the entity's paper, RBS is retaining it in case future capital constraints create the need for assets that could be pledged against Bank of England repurchase facilities. That said, it still could offer the securities to open-market buyers down the road.

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