Fears for commercial paper grow


By Saskia Scholtes, Peter Thal Larsen, and David Oakley
Financial Times, London
Thursday, August 16, 2007


A group of financial institutions said yesterday they had agreed to a plan to end a liquidity crisis in the Canadian commercial paper market, staving off immediate problems but throwing fresh focus onto short-term funding troubles in other markets.

The agreement, which covers about two-thirds of Canada's outstanding asset-backed commercial paper (ABCP), removes some of the immediate concerns about liquidity in the Canadian market.

However, anxiety about the lack of liquidity in the US market continued as the Federal Reserve reported that the total amount of CP outstanding plunged in the week ended August 15, falling $91 billion to $2,132billion.

The problem is epitomised by Countrywide Financial, the mortgage lender, which drew down $11.5 billion of credit lines overnight on Wednesday to boost its cash position after facing difficulty in CP markets.

Investors were also refusing to buy paper outside the US. Of the $45 billion of non-US CP maturing on Thursday, only 40 per cent had been rolled over at the end of the London trading day, forcing many borrowers to seek other credit lines.

CP is an important source of short-term funding for companies and financial institutions. Recent illiquidity has been triggered by credit worries, including losses on debt securities backed by US subprime, or low credit quality, mortgages. ABCP is often issued to fund portfolios of securities backed by mortgages and other loans. Sharp drops in the value of some such securities have rattled CP lenders in recent weeks, following losses at hedge funds and other investment groups that owned subprime-related bonds.

The Canadian market ground to a halt earlier this week when a significant number of large institutions found they could no longer issue CP.

John Kemp, economist at Sempra Metals said: "The need for a coordinated rescue of an entire financial market outside the United States is a sign of how far the current lending and liquidity crisis is being transmitted through the financial system of the advanced industrial economies."

The deal was signed by a number of international banks such as ABN Amro, Deutsche Bank and HSBC, Merrill Lynch, and UBS. It involves the conversion of outstanding ABCP, which normally mature in one to three months, into five-year floating-rate notes. This will remove the immediate uncertainty about lenders' ability to renew these debts.

People familiar with the agreement said investors had also agreed to remove triggers that forced the underlying assets to be sold when they fell below a certain price. This mechanism is thought to have helped drive down prices in recent weeks, even though the creditworthiness of the underlying assets has not changed.

The agreement is seen by some participants as a possible template for resolving blockages in other ABCP markets around the world. There is concern in Europe that banks may have to absorb tens of billions of dollars of ABCP on to their balance sheets. This would eat into their capital reserves and could trigger a broader credit crunch.

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