What is an Asset-Backed Commercial Paper (ABCP)?
An asset-backed commercial paper (ABCP) is a short-term investment vehicle with a maturity date typically between 90 and 270 days. A bank or other financial institution generally issues the security. The notes are backed by the company’s physical assets, such as trade receivables. Companies use asset-backed commercial paper to fund short-term financing needs.
Key Takeaways
- Short-Term Investment: An ABCP is a type of short-term investment with a maturity date of no more than 270 days.
- Issued by Financial Entities: A bank, financial institution, or large corporation typically issues ABCPs, which are notes backed by collateral.
- Collateral Composition: The collateral often consists of the corporation’s expected future payments or receivables.
- Diverse Receivables: These receivables might include payments the corporation expects to collect from loans it has made, such as auto loans, credit card debt, student loans, or residential mortgages.
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, set up by a sponsoring financial institution. The maturity date of an ABCP is set at no more than 270 days and issued either on an interest-bearing or discount basis.
The note is backed by the corporation’s collateral, which might include future payments to be made on credit cards, auto loans, student loans, and collateralized debt obligations (CDOs). These expected payments are collectively known as accounts receivables. The proceeds of an ABCP issue are primarily used to obtain interests in various types of assets, either through asset purchase or secured lending transactions. A company can create an ABCP from any type of asset-backed security, including subprime mortgages.
Comparing Commercial Paper (CP) and Asset-Backed Commercial Paper (ABCP)
The primary difference between commercial paper (CP) and asset-backed commercial paper (ABCP) is that commercial paper is not backed by assets. Commercial paper (CP) is a money market security issued by large corporations to raise money to meet short-term obligations. With a fixed maturity of less than one year, commercial paper acts as a promissory note backed only by the high credit rating of the issuing company.
Investors purchase commercial paper at a discount to face value and are repaid the full face value of the security at maturity. Since standard commercial papers are not backed by collateral, only firms with excellent credit ratings from a recognized credit rating agency can sell commercial papers at a reasonable price. A type of commercial paper backed by other financial assets is called asset-backed commercial paper.
A company or bank looking to enhance liquidity may sell receivables to an SPV or other conduits, which, in turn, issue them to 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, responsible for disbursing the funds generated by the receivables to the ABCP noteholders.
ABCP Interest Payments
During the investment’s life, the sponsoring financial institution that set up the conduit is responsible for monitoring developments that could affect the performance and credit quality of the assets in the SPV. The sponsor ensures that ABCP investors receive their interest payments and principal repayments when the security matures.
The interest payments made to ABCP investors originate from the pool of assets backing the security, e.g., monthly car loan payments. When the collateralized paper matures, the investor receives a principal payment funded either from the collection of the credit’s assets, the issuance of new ABCP, or by accessing the credit’s liquidity facility.
Special Considerations
While most ABCP programs issue commercial paper as their primary liability, funding sources have been extensively diversified lately to include other types of debt. This includes medium-term notes (MTNs), extendible commercial paper, and subordinated debt to provide credit enhancement.
One significant concern about ABCPs and related investments stems from the possibility of liquidity risk. If the market value of the underlying assets decreases, the safety and value of the ABCP might also suffer.
It’s important for ABCP investors to understand the composition of the underlying assets and how the value of those assets might be impacted by market stresses, such as a downturn in the economy. The inability in some circumstances for investors to sell their investments quickly to minimize losses is just one of the risks associated with asset-backed commercial paper.
Related Terms: commercial paper, accounts receivables, special purpose vehicle, collateral, asset-backed security.
