Asset-Backed Commercial Paper (ABCP)

An asset-backed commercial paper (ABCP) is a short-term investment vehicle with a maturity that is typically between 90 and 270 days. The security itself is typically issued by a bank or other financial institution. The notes are backed by physical assets such as trade receivables and are generally used for short-term financing needs.

Commercial paper (CP) is a money market security issued by large corporations to raise money to meet short-term obligations. With a fixed maturity of less than one year, the commercial paper acts as a promissory note that is backed only by the high credit rating of the issuing company. Investors purchase the note at a discount to face value and are repaid the full face value of the security at maturity. Since the standard commercial papers are not backed by collateral, only firms with excellent credit ratings from a recognized credit rating agency will be able to sell commercial papers at a reasonable price. A type of commercial paper that is backed by other financial assets is called an asset-backed commercial paper.

Asset-backed commercial paper (ABCP) is a short-term money-market security that is issued by a special purpose vehicle (SPV) or conduit, which is set up by a sponsoring financial institution. The maturity date of an ABCP is set at no more than 270 days and issued either on an interest-bearing or discount basis. The note is backed by collateral which includes future payments to be made on credit cards, auto loans, student loans, and collateralized debt obligations (CDOs). These expected payments are collectively known as receivables. The proceeds of an ABCP issue is used primarily to obtain interests in various types of assets, either through asset purchase or secured lending transactions.

A company or bank looking to enhance liquidity may sell receivables to an SPV or other conduits, which, in turn, will issue them to its investors as commercial paper. The commercial paper is backed by the expected cash inflows from the receivables. As the receivables are collected, the originators are expected to pass the funds to the conduit, which is responsible for disbursing the funds generated by the receivables to the ABCP noteholders. During the life of the investment, the sponsoring financial institution that set up the conduit is responsible for monitoring developments that could affect the performance and credit quality of the assets in the SPV. The sponsor ensures that ABCP investors receive their interest payments and principal repayments when the security matures.

The interest payments made to ABCP investors originate from the pool of assets backing the security, e.g. monthly car loan payments. When the collateralized paper matures, the investor receives a principal payment that is funded either from the collection of the credit’s assets, from the issuance of new ABCP, or by accessing the credit’s liquidity facility.

While most ABCP programs issue commercial paper as their primary liability, funding sources have been extensively diversified lately to include other types of debt, such as medium-term notes, extendible commercial paper, and subordinated debt to provide credit enhancement.