Asset-Backed Commercial Paper (ABCP)

What Is an Asset-Backed Commercial Paper (ABCP)?

An asset-backed commercial paper (ABCP) is a short-term investment vehicle with a maturity date that is normally somewhere in the range of 90 and 270 days. A bank or other financial institution normally issues the security itself. The notes are backed by the company's physical assets, for example, trade receivables. Companies will utilize an asset-backed commercial paper to fund short-term financing needs.

Understanding Asset-Backed Commercial Paper (ABCP)

Asset-backed commercial paper (ABCP) is a short-term money-market security that is issued by a special purpose vehicle (SPV) or conduit, which is set up by a sponsoring financial institution. The maturity date of an ABCP is set at something like 270 days and issued either on an interest-bearing or discount basis.

The note is backed by the corporation's collateral, which could incorporate future payments to be made on credit cards, vehicle loans, student loans, and collateralized debt obligations (CDOs). These expected payments are collectively known as receivables. The proceeds of an ABCP issue is utilized basically to acquire interests in different types of assets, either through asset purchase or secured lending transactions.

A company can make an ABCP from an asset-backed security, including subprime mortgages, which are high-risk mortgages that were one of the principal impetuses of the 2008 financial crisis.

Commercial Paper (CP) versus Asset-Backed Commercial Paper (ABCP)

The primary difference between commercial paper (CP) and asset-backed commercial paper (ABCP) is that commercial paper isn't backed by assets. Commercial paper (CP) is a money market security issued by large corporations to fund-raise to meet short-term obligations. With a fixed maturity of short of what one year, the commercial paper acts as a promissory note that is backed exclusively by the high credit rating of the responsible company.

Investors purchase the commercial paper at a discount to face value and are reimbursed the full face value of the security at maturity. Since standard commercial papers are not backed by collateral, just firms with phenomenal credit ratings from a recognized credit rating agency will actually want to sell commercial papers at a reasonable price. A type of commercial paper that is backed by other financial assets is called an asset-backed commercial paper.

A company or bank hoping to upgrade liquidity may sell receivables to a SPV or different conduits, which, thusly, will issue them to its investors as asset-backed commercial paper. The ABCP is backed by the expected cash inflows from the receivables. As the receivables are collected, the originators are expected to pass the funds to the conduit, which is responsible for dispensing the funds created by the receivables to the ABCP noteholders.

ABCP Interest Payments

During the life of the investment, the sponsoring financial institution that set up the conduit is responsible for monitoring improvements that could influence the performance and credit quality of the assets in the SPV. The sponsor guarantees that ABCP investors receive their interest payments and principal repayments when the security develops.

The interest payments made to ABCP investors start from the pool of assets backing the security, e.g., month to month vehicle loan payments. At the point when the collateralized paper develops, the investor receives a principal payment that is funded either from the collection of the credit's assets, from the issuance of new ABCP, or by getting to the credit's liquidity facility.

Special Considerations

While most ABCP programs issue commercial paper as their primary liability, funding sources have been widely diversified recently to incorporate different types of debt. This incorporates medium-term notes (MTNs), extendible commercial paper, and subordinated debt to give credit enhancement.

One critical concern about ABCPs and related investments comes from the possibility of liquidity risk. In the event that the market value of the underlying assets diminishes, the safety and value of the ABCP could likewise endure.

ABCP investors really must comprehend the organization of the underlying assets and how the value of those assets may be influenced by market stresses, like a downturn in the economy. The failure in certain conditions for investors to sell their investments rapidly to limit losses is just one of the risks associated with asset-backed commercial paper.

Highlights

• These receivables could incorporate payments the corporation hopes to collect from loans it has made, for example, vehicle loans, credit card debt, student loans, or residential mortgages.
• The collateral frequently comprises of the corporation's expected future payments or receivables.
• An asset-backed commercial paper (ABCP) is a type of short-term investment with a maturity date of something like 270 days.
• A bank, financial institution, or large corporation regularly issues ABCPs, which are notes backed by collateral.