Secured Commercial Paper FacilityThe BoE has announced that the number of firms benefiting from the SCPF to date is-nil. Zero. Not a single one.
Why is this? One reason may be that the original concept was fairly academic. It wanted to fund via commercial paper conduits, presumably because they are already there. But conduits can fund themselves cheaply by issuing in US dollars and swapping via the spot-forward market anyway. The BoE also insists on a rating. But getting ratings on small pools of receivables is labour intensive. So why wouldn't an arranging bank just stick with bigger customers. Which is what has happened to date.
So the poor old MMCs miss out again. The next initiative is supply chain finance. There's a lot more mileage here, but there are still inherent problems:
-Big banks aren't lending as much as they should, or indeed promised. Why would they lend any more under SCF?
-Everyone's simplistic illustration is a small customer selling to, say, Tesco. Under SCF the supplier gets paid up front, and the "lender" collects from Tesco in e.g. 90 days. That gives everyone a rating to cling to. But the real requirement is MMC to MMC business, where there isn't a rating.
-So we need some credit insurance. But credit insurers also only want the best risks. So the unloved MMCs are left grovelling to the banks.
Incidentally, I'm constantly amazed how many capital markets firms assert that they don't rely on ratings, do their own credit work etc etc-but actually cling to ratings like a toddler to its security blanket.
What we need is either a trade receivables-type rating approach-the credit enhancement comes from the discount on purchase, not a third party-or an insurer to enter the market and grasp this opportunity in the same way as ACE and XL did some years ago in a different insurance sector when reinsurers were running scared.
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The FT today reports that Lloyds Bank, 43% government owned, wants to free itself of the obligation to enter into the government-sponsored Asset Protection Scheme (APS). The suggested price is £1bn. That looks like a good deal for Lloyds.
The APS was announced in the dark days of January, and was a good idea at the time. It proposed insuring hundreds of billions of "toxic" assets on the balance sheets of RBS and Lloyds (well, the bit over a 10% first loss to be taken by the banks)in return for large fees payable to HM Govt and making large lending commitments-£9b of mortgage lending an £16b of business lending in the case of RBS. Most reports state that the latter condition has been reneged on.
The world looks very different now compared to January. 3 month Libor indicates how well bank funding is working. It was then Base+75bp; it is now Base+6bp. AAA asset backed bonds have gone from 60-ish to 90-ish. Other banks have found market-driven solutions, such as Barclays' Protium, where $12.3bn of assets have been hived off into a separate asset management company. Several other banks are said to be looking at this approach.
The APS, ironically, has probably done its job by the very fact of being announced. Time to move on.
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The FSA has announced new and stricter rules for bank liquidity. This will involve qualitative changes (how good the short-term assets held are), and quantitative changes (how much a bank has to hold).
The FSA specifically mentions government bonds as a desirable asset to hold. This no doubt suits this government and its successor.
The problem for banks is that these are the lowest-yielding assets. So in order to make a loan, a bank has to borrow not only enough money to fund the loan, but also borrow some more to buy govt bonds. The downside is of course that the income from the lovely liquid assets is lower than the cost of funding, so the bank loses a spread-which it presumably passes on to its borrowers in the form of higher margins.
The FT estimates that UK banks will have to "increase their holdings of cash and government bonds by £110bn and cut their reliance on short-term funding by 20 per cent in the first year alone".
ABS of course involves the issuance of debt which is as long as the underlying assets, so there is no asset/liability mismatch and no reliance on short-term funding. Expect an increase in issuance once the real cost of the new liquidity rules has become clear to banks.
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I had a discussion recently with a fund manager which intends to offer hybrid bank capital to investors. Sounds good on the surface: a well-recognised name and a yield of 7-8%. And the bank gets a tax deduction as if it had issued debt. Doubles all round!
Scratch that same surface, however, and big problems are apparent:
*The Bank for International Settlements (BIS) issued a press release last month in which they state "The predominant form of Tier 1 capital must be common shares and retained earnings". You can't get much clearer than that. As Euroweek put it, the BIS's statement "...is the strongest indication yet that hybrids are history".
*Rating agencies are not keen either. S&P wrote back in 2006 "Owing to the unpredictable nature of some of the risks to which hybrid capital issue ratings are subject, the ratings are potentially more volatile than the ratings on conventional debt issues".
*It's not long since too-clever-by-half banks were issuing this stuff and buying back their own shares. Here's a quote from 2005 "On average, the cost of this kind capital is only 50 to 75 basis points more than senior term debt," said Erin Callan, head of global finance solutions at Lehman Brothers. "Historically, that is the all-time tightest level it has ever been." You can see why the BIS is concerned.
What sort of people were buying this overstructured and overpriced paper?
Finally, why would any rational person buy paper with equity-type risks for a yield lower than you can get on very solid RMBS paper with the highest AAA rating?
Efficient markets, anyone?
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I'm working on a deal where we need to get a particular type of insurance. Since this is not a field where I am up to date, we need to engage a broker. The way in which remuneration works in this world reminded me of what I term the paradox of the broker: he's officially acting for you, but does the remuneration model stack up?
The broker most people know best is the estate agent. You are probably familiar with the deal-the estate agent tells you your house is worth £1m, for the sake of illustration. You instruct him to sell, and he gets 2% of the proceeds, in this case £20k. The estate agent comes back to you after a few weeks and tells you that the market has changed (or whatever), and that you should accept £950k.
What does this mean for the parties? You are out of pocket by £50k, but have saved 2% of £50k (£1k) on agent's fees. So you're down £49k. The agent gets £19k not £20k, a nice deal for him on a quick sale. Was he motivated to put in the extra effort to get to the original price? I'd like to think so, but probably not in all cases.
I once put this to an estate agent: "I'll pay you 1% on the first 90% of your indicated selling price, and and 10% on anything over that. That way, if you get to 100% you're quits, and you make 10% of everything else". Did he accept? No. I wonder why?
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