Even though the Fed cut the discount rate to 5.75%, and more important, said it was concerned about risks to growth, asset backed commercial paper, which is the epicenter of the credit shock, is being placed at newly high yields: 5.99%, which is now above the discount rate. And remember, not only has the Fed now extended the term of these loans from overnight to 30 days, but it has implied that it will keep this practice going indefinitely.
What gives? Reading the Bloomberg story, it appears to be prejudice, both against the paper itself and going to the discount window. No way, no how do investors want anything to do with anything within hailing distance of subprime.
If you are looking at this from an investment perspective, it’s irrational (if you are a bank, buy the CP, go to your friendly Fed and and make a spread. Now I haven’t factored in the cost of reserves and equity, so the math might not work after all. But it looks like there might be a simple arbitrage here).
However, ” buying subprime” appears to equate to “career limiting move.” Hence the continued difficulty in placing ABCP.
Asset-backed commercial paper yields soared by the most since the Sept. 11, 2001, terrorist attacks after the Federal Reserve cut its discount rate to try to calm financial markets.
Top-rated asset-backed commercial paper maturing Aug. 20 yielded 5.99 percent, up 39 basis points since yesterday and the most since a 45 basis point increase on Sept. 20 in the wake of the terrorist attacks in New York City and Washington.
Issuers are offering the highest rates in almost seven years to entice lenders who are trying to avoid taking mortgage- backed securities as collateral to avoid exposure to losses from U.S. subprime mortgage delinquencies.
The Fed’s action “may help add confidence that action will be taken when it’s necessary, but further action is needed to actually offset the credit contraction we have had,” Ashish Shah, global head of credit strategy at Lehman Brothers Holdings Inc. said in interview from New York. “No one actually wants to tap the Fed window. So while this is good, it doesn’t actually add any liquidity into the system. It’s more of a confidence booster.”
Yields on asset-backed commercial paper rated A1, the second-highest at Standard & Poor’s, and maturing the next day rose 39 basis points to 6.01 percent, the highest since January 2001, according to data compiled by Bloomberg. The increase is also the biggest since September 2001.
The Fed said today that while recent reports indicate economic growth continues at a “moderate pace,” risks to the expansion have risen “appreciably” and “financial market conditions have deteriorated.”
Removing the Stigma
The Fed is trying to encourage banks to buy commercial paper by allowing institutions to borrow for 30 days rather than overnight and making it renewable at the borrower’s option, according to Drew Matus, an analyst at Lehman Brothers Holdings Inc. in New York.
The Fed’s action “essentially removes the stigma of accessing the discount window as well as providing a means of financing a wider range of collateral, Lehman said.
Federated Investors in Pittsburgh is buying some asset- backed commercial paper because it’s a good value, said Deborah Cunningham, chief investment officer for Federated who oversees $193.4 billion in money market funds including commercial paper.
“They are obviously sending a signal to the marketplace that, `We’re in with you on this,”’ said Cunningham.
The asset-backed market still “lacks sponsorship” and is having a “buyers’ strike,” Mark Amberson, who runs the $5 billion Russell Money Market Fund for the Russell Investment Group in Tacoma, Washington, said in an e-mail. Amberson said he was enticed to buy some commercial paper at an overnight yield of more than 6 percent today and that he won’t buy asset-backed debt maturing in more than seven days.
The Fed is trying to help find buyers for commercial paper after the market seized up this week for Countrywide Financial Corp., the biggest U.S. mortgage lender. Countrywide borrowed its entire $11.5 billion available in bank credit.
Countrywide turned to the emergency loan, which it said was provided by a group of 40 banks, a day after Merrill Lynch & Co. raised the prospect of bankruptcy for the Calabasas, California- based lender. Australia’s Rams Home Loans Group Ltd. and Canada’s Coventree Inc. also sought emergency funding today.
“Confidence equals liquidity,” said Tony Crescenzi, chief bond market strategist for New York-based Miller Tabak & Co. and author of a 2007 edition of Stigum’s Money Market, a textbook first published in 1978. “Credit spreads will tighten and, with the Fed supplying credit, fears should subside and help to open the credit spigot again.”
Investors began to demand higher yields on asset-backed commercial paper conduits, some of which own mortgages, after BNP Paribas SA froze withdrawals from three investment funds that invested in subprime bonds. BNP’s decision caused overnight lending rates between banks to soar and prompted the European Central Bank to lend 94.8 billion euros ($130.2 billion).
The gap between similarly rated asset-backed and direct- issued paper is 79 basis points, the most since Bloomberg began keeping the indexes in 1999. Sellers are offering direct-issued commercial paper at yields of about 5.2 percent, the same as yesterday and down 5 basis points this week.
Commercial paper is bought by money market funds, mutual funds that invest in short-term debt securities. In asset-backed commercial paper, the cash is used to buy mortgages, bonds, credit card and trade receivables as well as car loans. Some of the programs are backed by subprime loans.
No matter what they say, the practice will not be going on indefinitely.
The banks know the feds’s offer might be openended, but temporary