Cantor Fitzgerald LP, the bond broker run by Howard Lutnick, is jumping into a part of the shadow banking system that shrank 73 percent in five years.
The firm is arranging a fund that aims to issue as much as $20 billion of commercial paper to help finance banks, the first of its kind to be rated this year by Moody’s Investors Service or Standard & Poor’s. The borrowing will be backed by arrangements that allow “major global banks” to shift assets of any type into the pool as collateral, with the promise of repurchasing them or covering losses.
Cantor is betting demand will return to a market that is extending declines started during the U.S. housing crisis in 2007, when it peaked at $1.2 trillion. Outstanding asset-backed commercial paper in the U.S. fell 15 percent the past year to $323.6 billion as investors avoided debt of European lenders amid the region’s fiscal crisis and regulators debate rules to stem risks from financial markets, Federal Reserve data show.
Investors “have the appetite for more product, but the banks, because of regulatory uncertainty with respect to ABCP, are waiting on getting back into the market,” said Philip Galgano, head of S&P’s asset-backed commercial paper ratings.
Financial activities less regulated than traditional lending, known as shadow banking, have been shrinking as regulators seek to restrict the risks banks can take with their money and to retain greater stakes in assets that are packaged and sold off to investors.
A Deloitte LLP index that tracks transactions from money market funds and repurchase agreements to mortgage-backed securities and asset-backed commercial paper had declined to $9.53 trillion at the end of 2011, more than 50 percent below its peak in 2008, the accounting firm in New York said May 29.
Regulations are fueling some ABCP funds, with banks such as JPMorgan Chase & Co. and Barclays Plc setting up conduits to use on their own to convert repurchase-agreement, or repo, borrowing into commercial paper. New York-based Cantor’s fund, known as Institutional Secured Funding, will be open to multiple banks.
Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. rose for a third day, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, climbing by 2.5 basis points to a mid-price of 125.8 basis points as of 11:54 a.m. in New York, according to prices compiled by Bloomberg. The index has increased from 117.4 at the end of last week.
The index typically rises as investor confidence deteriorates and falls as it improves. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
The U.S. two-year interest-rate swap spread, a measure of bond market stress, rose 1.9 basis points to 37.2 basis points as of 11:55 a.m. in New York. That’s the highest level on an intra-day basis since May 23 for the gauge, which widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.
Bonds of BRF - Brasil Foods SA (BRFS3) are the most actively traded dollar-denominated corporate securities by dealers today, with 51 trades of $1 million or more as of 11:56 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The company sold $500 million of 5.875 percent, 10-year notes yesterday.
Cantor, which has been working to transform itself into a full-service investment bank, is building its asset-management, sales and trading businesses as an accelerating number of firms exit fixed-income. It is one of 21 primary dealers authorized to trade U.S. government securities with the Fed.
The firm’s asset-backed commercial paper program, which will be available only to banks with top short-term ratings from S&P and Moody’s, seeks to sell U.S. and euro-denominated notes that generally come due within 397 days, Cantor said in a May 23 statement.
The program “enables us to provide our clients around the world with access to securities and receivable financing, underscoring our commitment to continually serve their needs across the fixed income spectrum,” Chief Executive Officer Shawn P. Matthews said in the statement.
S&P, which rates 121 asset-backed commercial paper programs globally, has withdrawn more than 200 ratings on such funds since the beginning of 2008. It has ratings outstanding on 65 programs in the U.S.
The decline in outstanding U.S. asset-backed commercial paper resumed late last year after growth of about $35 billion in the nine months through August to $394 billion, Fed data show. The market shriveled through 2009 after losses on issuers known as structured investment vehicles that lacked support from banks and changes in accounting rules that forced lenders to bring many of the programs onto their balance sheets.
Regulatory changes also are fueling the declines. The so-called Volcker rule, which seeks to limit the risks banks can take with their own money, may also may restrict use of the commercial-paper funds known as conduits, said Alex Roever, JPMorgan’s head of short-term fixed-income strategy. Rules being written to force banks to retain stakes in securitizations may also affect the market.
The market’s decline last year was driven largely by money-market funds backing off of debt tied to European banks.
“You had some institutional investors calling up money managers and saying, ‘I’m reducing my allocation to your fund if you have this type exposure,’” said Garret Sloan, a money-market analyst in Charlotte, North Carolina at Wells Fargo Securities LLC.
While regulations are squeezing certain types of commercial-paper vehicles, another set of rules are driving the push by Cantor and banks to start funds linked to repo agreements.
In a repo arrangement, a lender sends cash to a borrower in return for collateral such as Treasuries or mortgage bonds, which the borrower agrees to repurchase as soon as the next day. Interest and credit protection for the lender is built into how much cash gets extended and returned.
Tapping money-market funds for such borrowing became more difficult as a result of rule changes created in 2010 that limit the investors’ holdings of illiquid assets maturing in more than seven days to 5 percent, down from 10 percent.
Those rules changed after the $62.5 billion Reserve Primary Fund “broke the buck” in September 2008 when Lehman Brothers Holdings Inc. debt dragged it down to 97 cents per share, sending investors fleeting the money-market industry at the height of the financial crisis.
Turning the repo into commercial paper before selling it broadens the types of buyers and makes it easier to trade. Banks also need to find financing with longer maturities amid changing regulations pending under international rules known as the Basel III accord, Roever said.
With repo-backed conduits, banks “can push the maturity of that paper away from overnight to something longer, like one or two months,” he said.
JPMorgan in October created its Collateralized Commercial Paper Co. LLC, which is used only by the company and has about $3 billion of notes outstanding, said John Kodweis, head of short-term credit origination at its investment bank.
“We developed this as one of many financing options,” he said in a telephone interview. “It’s really intended to lengthen the term of our non-traditional repo book in a transparent and straightforward way.”
The assets being placed in the conduit remain on the bank’s balance sheet under accounting rules, as they would with repo agreements with other counterparties, and buyers of the commercial paper see a full list of what they are and at what prices they’re held, he said. Eligible securities include equities, U.S. corporate bonds and convertibles, Fitch said in an October report.
Guggenheim Partners LLC’s Liberty Hampshire, which runs funds similar to Cantor’s, is among survivors in the market, and a new company called 20 Gates Management LLC has since entered the business.
Felipe Ucros, a spokesman for Liberty Hampshire, declined to comment, as did Mark Lane, a spokesman for Barclays, whose Barclays CCP Funding LLC issuance is set up to represent a direct liability of the bank.
Banks looking to transform repo agreements into commercial paper may want to use to joint funds because of “scale,” said Hans Bald, CEO of 20 Gates, which helps banks run conduits and last year assumed management of Mountcliff Funding LLC, a vehicle set up by Hudson Castle that’s similar to Cantor’s.
“There is an enormous reward in the market by running a large vehicle,” said Bald, whose New York-based firm also offers banks advice on liquidity. With money-market funds limited by the percentage of a commercial-paper program they can hold at any time, “you’re absolutely dead in the water, or at least in a whole different category, if you’re under $2 billion or $3 billion,” he said.
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