What is asset-backed commercial paper (ABCP)?
– ABCP is a short-term debt instrument (a money-market security) with a maturity usually no longer than 270 days. Instead of being an unsecured promise to pay, ABCP is issued by a special-purpose vehicle (SPV) or conduit and supported by a pool of financial assets — for example, credit-card receivables, car-loan payments, student loans, or other receivables. A sponsoring bank or financial company typically creates and oversees the conduit.
How ABCP differs from plain commercial paper (CP)
– Commercial paper (CP) is unsecured short-term debt issued directly by corporations that rely on their creditworthiness. ABCP is similar in tenor to CP but is backed by the cash flows from an underlying asset pool and is issued by an SPV rather than the originator itself. Because ABCP has collateral or other credit supports, it can attract investors even when the originator’s own credit profile is less prominent.
Basic structure — step-by-step
1. Originator (company or bank) creates receivables (e.g., loans, credit-card balances).
2. Originator sells or transfers those receivables to an SPV/conduit.
3. The SPV funds the purchase of assets by issuing ABCP to investors.
4. Investor cash is repaid at maturity from collections on the asset pool, by issuing new ABCP (rollover), or from a liquidity facility provided by the sponsor or another backstop provider.
5. The sponsor monitors asset performance and may provide credit or liquidity support (credit enhancement) to protect investors.
Key terms (defined)
– Special-purpose vehicle (SPV): a legally separate entity created to hold assets and issue securities, isolating the originator from certain risks.
– Accounts receivable: expected future cash inflows from customers (e.g., loan or card payments).
– Liquidity facility: a commitment (usually from a bank) to purchase or provide funds to the conduit if it cannot roll or sell ABCP when it comes due.
– Credit enhancement: mechanisms (liquidity facilities, subordinated debt, guarantees) that improve the credit profile of the ABCP.
– Liquidity risk: the risk that investors can’t sell their holdings quickly or that the conduit cannot refinance outstanding paper.
How investors get paid
– ABCP can be issued at a discount (investor buys below face value and receives face at maturity) or as interest-bearing paper (periodic or lump-sum interest). The cash flows to investors come from collections on the underlying assets, proceeds from new issuance, or drawdowns on liquidity support.
Important risks and considerations
– Asset-quality risk: If the underlying receivables lose value (e.g., higher default rates), cash available for investors falls.
– Liquidity/rollover risk: Conduits often rely on issuing new short-term paper to pay maturing ABCP. In stressed markets, that funding can dry up.
– Counterparty risk: If a liquidity provider or sponsor fails to perform, investors may not get timely payments.
– Transparency: Investors need to know the composition and credit quality of the asset pool to assess risk.
– Market history: ABCP markets experienced severe strain during past crises when asset values and short-term funding both deteriorated.
Checklist for evaluating an ABCP issue
– Who is the sponsor? (reputation, capitalization)
– What legal form is used? (SPV/conduit details)
– What types of assets back the paper? (credit-card receivables, auto loans, mortgages, etc.)
– Is there an independent credit rating? What does it reflect?
– Is there liquidity support or credit enhancement? What are its terms and provider?
– Maturity length and rollover profile: how often is the paper rolled?
– Secondary-market liquidity: how easy is it to sell before maturity?
– Fees, taxes, and settlement mechanics
– Stress scenarios: how would reduced collections affect payback?
Small worked numeric example (discount issue)
Assumptions
– Face value at maturity: $1,000
– Tenor: 90 days
– Quoted bank discount yield: 1.50% (annualized on 360-day basis)
Step 1 — compute price on a bank discount basis:
Price = Face × (1 − discount × days/360)
Price = 1,000 × [1 −
…discount × days/360)]
Price = 1,000 × [1 − 0.015 × 90/360]
Price = 1,000 × [1 − 0.015 × 0.25]
Price = 1,000 × [1 − 0.00375]
Price = 1,000 × 0.99625 = $996.25
Step 2 — compute the dollar discount (the investor’s purchase discount):
Discount = Face − Price = $1,000 − $996.25 = $3.75
Step 3 — convert the quoted bank-discount yield into yields investors commonly use
Definitions and formulas:
– Bank discount yield (quoted) = (Discount / Face) × (360 / days)
– Money-market (investment) yield = (Discount / Price) × (360 / days)
– Bond-equivalent or annualized yield (365-day basis) = (Face / Price − 1) × (365 / days)
Compute each:
a) Bank discount yield (given/check)
(3.75 / 1,000) × (360 / 90) = 0.00375 × 4 = 0.0150 = 1.50% (matches the quoted rate)
b) Money-market (investment) yield — annualized on 360-day basis
(3.75 / 996.25) × (360 / 90) = 0.003765 × 4 = 0.0150596 = 1.50596% ≈ 1.506%
c) Bond-equivalent / 365-day annualized yield
(1,000 / 996.25 − 1) × (365 / 90) = 0.003765 × 4.05556 = 0.015271 =
= 0.015271 = 1.5271% ≈ 1.527%
Interpretation and why the three yields differ
– Bank discount yield (quoted) expresses the discount as a percentage of the face value (par) and uses a 360-day year. It understates the true investment return because the base is the larger face value, not the actual price paid.
– Money‑market (investment) yield annualizes the actual return (discount divided by price) on a 360‑day basis. It reflects the investor’s realized return more accurately than the bank discount yield for short-term instruments.
– Bond‑equivalent yield (BEY) annualizes the actual return on a 365‑day basis and is useful for comparing short-term discount instruments to bonds that conventionally use a 365‑day year. BEY = (Face/Price − 1) × (365 / days).
Practical checklist: converting among yields for a discount instrument (face F, price P, days to maturity d)
1. Compute discount = F − P.
2. Bank discount yield (BDY): (discount / F) × (360 / d).
3. Money‑market (investment) yield (MY): (discount / P) × (360 / d).
4. Bond‑equivalent yield (BEY): (F / P − 1) × (365 / d).
5. Check consistency: for short maturities differences are small; for longer d differences grow.
6. Always note which day count (360 vs 365) is being used when comparing instruments.
Worked numeric recap (using numbers from the example)
– Face F = $1,000; Price P = $996.25; discount = $3.75; days d = 90.
– BDY = (3.75 / 1,000) × (360 / 90) = 0.0150 = 1.500%.
– MY = (3.75 / 996.25) × (360 / 90) ≈ 1.506%.
– BEY = (1,000 / 996.25 − 1) × (365 / 90) ≈ 1.527%.
Notes and assumptions
– This example assumes simple (noncompounded) annualization appropriate for short-term money‑market instruments. It does not account for taxes, transaction costs, bid/ask spreads or reinvestment assumptions.
– “360‑day” conventions are common in money‑market quoting but are a market convention, not a physical calendar. When comparing with coupon bonds or other instruments, convert to a consistent day‑count basis.
Useful references
– Investopedia — Asset‑Backed Commercial Paper (definition and market context): https://www.investopedia.com/terms/a/asset_backed_commercial_paper.asp
– Board of Governors of the Federal Reserve — Commercial Paper: https://www.federalreserve.gov/releases/cp/
– U.S. Treasury — Treasury Bills: how discount yields are quoted (useful for conventions): https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield
– FINRA — Bonds and Yield Conventions (practical guidance): https://www.finra.org/investors/learn-to-invest/types-investments/bonds
– U.S. Securities and Exchange Commission — Money Market Funds and short‑term instruments: https://www.sec.gov/reportspubs/investor-publications/investorpubsmmfhtm.html
Educational disclaimer
This explanation is for educational purposes only and is not individualized investment advice. Always verify conventions and calculations with current market data and a qualified professional before making financial decisions.