Structured Finance and the Financial Turmoil of 2007 2008

1 finally an abcp program involves the presence of a

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often credit enhancement is sought (see section 3.1). Finally, an ABCP program involves the presence of a liquidity provider (bank or syndicate of banks) (see Figure 4), which commits itself to provide liquidity to the ABCP conduit in case of financing shortages (for example when the conduit cannot issue sufficient amounts of ABCP and consequently experiences a financing gap). This liquidity support may be important, since the ABCP issued has short to very short maturities. The ABCP market has been heavily hit by the 2007-2008 financial turmoil. When pressures stemming from the US subprime mortgage markets spilled over to structured finance products directly or indirectly linked to these markets, in August 2007 issuers of ABCP started to experience increasingly problems in finding investors willing to purchase these securities. The problem was that the exposure of ABCP programs to mortgage related financial instruments (which were included in the assets sold to conduits by collateral providers in Figure 4) had grown very fast to an estimated $300 billion [BIS (2007)], so that investors completely lost confidence in ABCP when the subprime tensions mounted, as potentially this instrument could incur significant losses due to the crisis. The high exposure of ABCP programs to mortgage markets is exemplified in Table 1, where it is shown that mortgages were the largest single collateral category ¡ representing more than one quarter of all collateral ¡ in US ABCP programs. 2 The ABCP conduits that were hit the hardest in the turmoil have been so-called Structured Investment Vehicles or SIVs, which specialized in investing in structured finance products. An overview of these and other ABCP conduits is provided in Table 2. Chart 3 shows that the amount outstanding of US ABCP, which is by far the main segment of the global ABCP market, started to decline rapidly in the third quarter of 2007 and that in 2008 outstanding levels remained at relatively subdued levels from a historic perspective. Table 1: Composition of the US ABCP market by collateral type (end-March 2007) Mortgages 26% CDOs 13% Credit card loans 10% Car loans 10% Commercial loans 7% Other 34% 100% SOURCE: JP Morgan (2007). 2 . The actual exposure to mortgage markets actually may have been higher, as other collateral types such as CDOs may have had exposures to prime and subprime mortgage markets as well.
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Figure 4: Example ABCP: Creation of Asset-Backed Commercial Paper (ABCP) by ABCP “conduits / structured investment vehicles (SIVs) (“true sale”) SOURCE: Adapted from: Fitch Ratings (2007), Moody’s (2003) and Fitch Ratings (2001). ABCP conduits/SIVs: Invest in assets sold by collateral providers; raise funds by issuing ABCP Investors in ABCP market Cash Credit enhancement (over-collateralization, insurance, etc.) Rating agencies Monolines Simplified structure : No separate administrator or servicer, asset owning SPVs, issuing & paying agent, dealers and conduit owner.
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