Asset-backed commercial paper programs.

In existence since 1983, asset-backed commercial paper programs have grown substantially over the past two years. These programs involve the securitization of assets and are attractive to companies because they provide a stable source of funding. At the same time, they appeal to banking organizations because they provide a means of earning fee income and meeting customers' needs for credit and, at the same time, eliminate the need to maintain the amount of capital that would be required if loans were extended directly to the companies.

Further incentive for participation in these programs has been provided by recent revisions to the Securities and Exchange Commission's rules limiting the amount that money market mutual funds may invest in commercial paper issues rated less than the highest quality. Through these programs, companies whose own commercial paper is rated below A1/P1 can continue to have access to the commercial paper market, despite the lower demand for commercial paper with such ratings.

This article examines the benefits and the risks of asset-backed commercial paper programs. First, it provides an overview of the commercial paper market and asset-backed commercial paper programs. Next, it discusses the mechanics of the securitization process, the role of banking organizations in the process, and the incentives for banks and customers to participate in such programs. Then it outlines the risks to which asset-backed commercial paper programs may expose banking organizations. It also addresses the risk-based capital treatment of the liquidity facilities and other supporting arrangements provided by banking organizations. Last, the article discusses how existing guidance on securitization activities that the Federal Reserve has provided its examiners pertains to asset-backed commercial paper.

OVERVIEW OF THE COMMERCIAL

PAPER MARKET

Commercial paper, one of the oldest money market instruments, is used to raise short-term funds. Typically, commercial paper is an unsecured, short-term promissory note issued in bearer form by a financial or nonfinancial company to satisfy its funding needs. Its popularity as a funding mechanism stems from (1) its availability as an alternative to short-term bank loans and (2) its lower relative costs when compared with bank loans or debt issuance. (1) To be exempt from securities registration requirements of the Securities and Exchange Commission (SEC), commercial paper must have a maturity of 270 or fewer days. (2) In practice, most commercial paper issues mature in 30 days or less, and the maturities of longer-term issues rarely exceed 90 days. While it is sometimes sold in denominations as small as $10,000, commercial paper is generally issued in denominations of millions of dollars to meet the requirements of money market funds and other institutional investors, which are the major purchasers.

The origins of commercial paper can be traced back to the 1800s. Because banking organizations were restricted to operating in one state, and often in only one location, companies in one area of the country might not be able to borrow needed funds from banking organizations in other regions. Thus, regions of the country with problems regarding the availability of credit often had interest rates higher than those in other regions. During times of high seasonal demand, companies in areas with relatively higher rates found the issuance of commercial paper to be a more cost-effective means of obtaining financing than borrowing under bank lines of credit. (3)

The growth of the market, however, essentially ceased from the Great Depression through World War II because of prevailing economic conditions. In the postwar economic boom, commercial paper again became a source of funding. During the 1960s and 1970s, growth in the commercial paper markets accelerated. One cause of the acceleration was the inability of banks to raise funds sufficient to meet corporate loan demand, which forced borrowers to look to the commercial paper market for credit. (4)

Many commercial and financial companies also discovered the commercial paper market to be a viable, cost-effective alternative to bank credit. Rates on commercial paper, Treasury bills, and certificates of deposit tend to move closely together, and all three generally change more quickly than the prime rate. During periods of falling interest rates, obtaining funds through the issuance of commercial paper may be cheaper because rates on such paper tend to move downward more quickly than the prime rate. Conversely, many commercial paper issuers have relied on bank loans during periods of rising interest rates because rates on these loans tend to change more slowly than rates on commercial paper. (5)

The growth of the commercial paper market continued to accelerate during the early 1980s as investors, because of their uncertainty regarding future rates, favored shorter maturities and as corporations waited for lower interest rates before issuing bonds. During this period, money market mutual funds grew exponentially and became the largest purchasers of commercial paper. The net effect of these events was a continued increase, not only in the dollar volume of the commercial paper market, but also in the number and type of issuers.

The amount of commercial paper outstanding in today's market is well above $500 billion (table 1). This amount represents obligations of domestic

1. Outstanding amount of commercial paper, selected years, 1960-91

Billions of dollars

             Year     Outstanding amount
1960                           4.5
1965                           9.3
1970                          33.4
1975                          48.4
1980                         124.4
1985                         298.8
1990                         566.9
1991 (to October)            528.3

SOURCE. Federal Reserve Bulletin.

financial and nonfinancial companies as well as of multinational corporations and foreign firms and shows a growth in volume of more than 90 percent from 1985 to 1990. Although commercial paper issues are generally unsecured, the liquidity of most issues is fully supported by bank lines of credit. Most borrowers in the market reissue or "roll over" commercial paper as the primary method of financing maturing paper. Although some secondary market activity is associated with commercial paper issues, original purchasers generally hold the paper to maturity.

OVERVIEW OF ASSET-BACKED COMMERCIAL

PAPER PROGRAMS

Like other securitization programs, asset-backed commercial paper programs segregate assets into pools and transform these pools into market instruments. The payment of principal and interest on these instruments stems from the cash flows collected on the underlying assets in the pool. In such programs, the underlying assets are the receivables of corporations, and the market instrument that is issued is commercial paper.

Asset securitization began in 1970 when the federal government through the Government National Mortgage Association (GNMA) stimulated the securitization of residential mortgages by guaranteeing investors the timely receipt of principal and interest on the securities issued under the GNMA program. Soon after, the Federal Home Loan Mortgage Corporation (FHLMC) and the Federal National Mortgage Association (FNMA) also began issuing mortgage-backed securities. In 1985, securities backed by computer leases, credit card receivables, automobile loans, and other types of loans began to be issued. (6)

Asset-backed commercial paper programs use a vehicle called a special purpose entity (SPE) to issue commercial paper. The programs provide a service basically similar to that offered by a factoring company in that the SPE finances the receivables of corporate clients. In other respects, however, the SPE differs from a factoring company. Typically, a factor assumes the role of a credit department for its clients to evaluate the creditworthiness of the clients' customers. While it finances a client's receivables by purchasing them, the SPE does not perform a credit evaluation of each obligor associated with the receivables in the pool as a factor would, but relies instead on an actuarial review of the past performance of the client's portfolio of receivables. Also, with an SPE, the corporate client usually performs the servicing function whereas in a factoring arrangement the factor generally services the receivables.

Unlike the more familiar mortgage or credit card securitizations, asset-backed commercial paper programs are ongoing activities that do not wind down by themselves after a few years. Generally, in the more traditional securitizations, the SPE holds a definitive pool of assets that back a specific issue of securities. Once the securities have been paid off, the transaction unwinds. In asset-backed commercial paper programs, the SPE continually purchases new receivables and usually rolls over the outstanding commercial paper.

Asset-backed commercial paper programs may differ from the more traditional securitization programs in several other ways. First, these programs issue short-term commercial paper as the instrument to fund the purchase of the underlying assets. Most other asset-backed instruments have maturities of more than two years. Second, the banking organization advising the program may provide credit enhancements or guarantees because the commercial paper is backed by assets sold to the SPE by nonrelated third parties. Generally, in the more traditional securitizations, in which the acquired assets are sold by the advising banking organization, credit enhancements are obtained from nonrelated third parties to ensure that, for accounting purposes, the selling institution can treat the transaction as a sale. Third, the commercial paper issued by these programs is less liquid than mortgage-backed securities and other types of asset-backed securities because no active secondary market exists.

At present, more than seventy asset-backed commercial paper programs are in operation, and estimates of the size of the market for this paper currently range from $50 billion to $70 billion. In the 1980s, programs advised by domestic banking organizations dominated the asset-backed commercial paper market. Currently, participants in this market also include foreign banking organizations, retail companies, and finance companies, which are estimated to account for one-half of the outstanding commercial paper issued by asset-backed commercial paper programs.

Standard & Poor's Corporation rated the first commercial paper program backed by pooled receivables in April 1983 and the second in January 1985 (chart 1). By year-end 1988, Standard & Poor's had rated eleven programs with the total capacity of issuing more than $16 billion of commercial paper. By November 1991, Standard & Poor's had rated sixty such programs, which have the capacity of issuing more than $48 billion of commercial paper. (7) (See table 2 for the various credit ratings and their definitions.)

THE SECURITIZATION PROCESS

Asset-backed commercial paper programs use an SPE to acquire legal title to receivables directly

[TABULAR DATA OMITTED]

from corporation. To date, the type of receivables that have been included in such programs are trade receivables, installment sales contracts, financing leases, noncancelable portions of operating leases, and credit card receivables. By using these programs, a bank can help arrange the financing of receivables for its corporate customers without having to make loans or purchase assets, which could inflate its balance sheet and increase its capital requirements. In some instances, these programs are designed to remove assets (typically credit card receivables originated by the bank) from the advising bank's books.

To avoid having to consolidate an SPE on its balance sheet, the advising bank does not own any of the capital stock. (8) Employees of an investment banking firm or some other third party generally own the equity of the SPE. As previously noted, to obtain funding the SPE issues commercial paper, which is ultimately repaid from the cash flow of the underlying pools of receivables. The rating agencies require that the entire amount of outstanding commercial paper be covered by liquidity and credit enhancements before the program receive the highest investment rating (see chart 2).

Bank involvement in an asset-backed commercial paper program can range from advising the program to advising and providing all of the required credit or liquidity enhancements needed to support the SPE's commercial paper. In most cases, the advising bank or an affiliate performs a review to determine whether the receivables of potential participants in the program--that is, the corporate sellers--are eligible for purchase by the SPE. The review is somewhat similar in scope to the review used in structuring securitizations backed by credit card receivables or automobile loans. It covers the credit origination standards of the corporation and the current and historical quality and performance of its portfolio. Ideally, the bank traces the performance of the corporation's portfolio through a complete business cycle and evaluates the current portfolio's expected performance. The bank reviews the receivables in the portfolio to make sure that they are widely distributed across regions of the country and among obligors and industries. Once a bank or its affiliate determines that a corporation's portfolio has an acceptable credit-risk profile, the bank or an affiliate approves the purchase of the company's receivables portfolio by the SPE.

The bank or an affiliate may also act as the operating agent for the SPE. Acting as operating agent entails structuring the sale sof pools of the corporate client's receivables to the SPE and continuously monitoring the performance of the pools. The SPE then issues commercial paper in an amount equal to the discounted purchase price of the receivables and uses the proceeds of the sale to buy the receivables from the seller. A company that sells its receivables to an SPE traditionally acts as the servicer for the receivables and, as such, is responsible for collecting interest and principal payments on the accounts from the obligors and for periodically passing these funds to the SPE.

Credit Enhancements and Liquidity Facilities

Asset-backed commercial paper programs typically have several levels of credit enhancement to protect investors from loss. The first level of protection in these programs is generally the difference between the face value of the receivables purchased and the discounted price paid, known as a holdback or overcollateralization. In some cases, the terms of the sale also give the SPE recourse back to the seller if there are defaults on the receivables. The amount of overcollateralization varies from pool to pool and depends mainly on the asset quality of the receivables originated by the corporate client and the desired credit rating for the commercial paper issued by the SPE. Usually, the level of credit protection provided by overcollateralization is specified as a multiple of historical losses.

The second level of credit safeguards is designed to absorb any losses that exceed the sum of the overcollateralization and recourse. Secondary credit enhancements include letters of credit, surety bonds, or other backup facilities, such as agreements that obligate a third party to purchase pools of receivables from the SPE at a specific price. The loss protection provided by the overcollateralization and secondary credit enhancements may range from 15 percent to 35 percent of the amount of commercial paper outstanding.

Besides the support provided by these credit enhancements, asset-backed commercial paper programs usually have support from a liquidity facility. The general purpose of the liquidity facility (sometimes referred to as a liquidity backup line) is to provide funds to the SPE to retire maturing commercial paper when a mismatch occurs in the maturities of the underlying receivables and the commercial paper obligations or when a disruption occurs in the commercial paper market. Thus, in its purest sense, the liquidity facility's purpose is to cover temporary shortfalls in the cash flows of the SPE that do not result from credit losses on the underlying receivables.

The credit enhancements and liquidity facility of an asset-backed commercial paper program may be provided separately or they may be provided together under a single arrangement with a bank. In a combined arrangement, a bank may be required to purchase pools of receivables to provide funds to the SPE to pay off maturing commercial paper, regardless of whether the funding shortfall resulted from credit deterioration in the particular pool or a liquidity problem in the overall commercial paper market.

When one bank provides both the credit and the liquidity support enhancements, whether in separate facilities or in a combined arrangement, the commercial paper's rating is integrally tied to the bank's own short-term rating. Recently, Standard & Poor's placed several asset-backed commercial paper programs on "Creditwatch," with negative implications, after the short-term deposit rating of the bank that provided the credit and liquidity enhancements was downgraded from A1+ to A1. The reason for the close scrutiny of these programs was their reliance on just one bank for both liquidity and credit support. In other asset-backed commercial paper programs, the A1+ ratings for the commercial paper were maintained, despite the deterioration of one bank's short-term rating because the bank was part of a diversified group of banks providing credit and liquidity support.

In rating the commercial paper issued through these programs, the rating agencies consider the protection provided investors by credit enhancements and backup liquidity facilities. Two criteria used by rating agencies are of particular importance. First, to obtain the highest credit rating, commercial paper issued by the SPE must generally have 100 percent liquidity support, which may be provided by a combination of the liquidity and credit enhancements. For example, if the program is protected by a 15 percent credit enhancement, a liquidity backup line of 85 percent will be necessary. Second, the rating on the commercial paper is integrally tied to the rating on direct obligations of the bank providing the enhancements. Thus, if the short-term deposit rating of the bank providing the enhancements is A2/P2, the commercial paper of the SPE will be given a similar rating at best and never a higher one.

Incentives for Banking Organizations

Through asset-backed commercial paper programs, banking organizations can help arrange short-term financing support for their customers without having to extend them credit directly. Thus, by keeping these potential loans off their books, banking organizations effectively reduce their capital requirements. Banking organizations also earn fee income for the service of packaging and monitoring pools of receivables as well as for providing liquidity facilities and credit enhancements. The programs therefore improve the performance measures of banks involved, not only because the fees earned add to revenue but also because revenue is increased without a corresponding increase in the banks' asset levels. Banks also contend that these vehicles allow them to help meet the financing needs of investment-grade customers that have relied on commercial paper in lieu of bank borrowing, and thus enable the banks to regain market share.

Incentives for Participating Companies

Companies wishing to obtain financing choose asset-backed commercial paper programs for several reasons. First, these programs provide participating companies with an additional, reliable source of funding at a relatively stable cost. This stability of funding costs results from the diversified pool of assets that back the commercial paper issued by the SPE and the extensive credit and liquidity support involved. Also, unlike traditional commercial paper programs, the cost of funding associated with these asset-backed programs is considered relatively stable because adverse conditions experienced by an individual participant generally do not affect the overall program's cost. Second, companies may want to clean up their balance sheets by reducing their total assets to improve performance ratios or by limiting the amount of their own paper outstanding in the market and, instead, issuing new paper through the SPE. Third, the funding costs associated with these asset-backed programs may be less than the direct funding costs for customers with a commercial paper rating below A1/P1. Finally, these arrangements may provide indirect access to the commercial paper market for companies that are unable to gain direct access.

Risks Associated with These Programs

Three fundamental models, with variants of each type, seem to underlie the structuring of the credit and liquidity support of these programs. First, a program can combine the credit and liquidity support into one arrangement; such a combination generally results in an effective guarantee of the entire amount of outstanding commercial paper. Second, a bank can provide separate credit and liquidity enhancements. Third, some programs have separate credit and liquidity support mechanisms provided by one or more third-party institutions. This last model is generally used when a bank is selling its own assets, typically credit and receivables, to the SPE. The bank uses this model to ensure that the transfer will be treated as a true sale of assets, that is, without any recourse to the bank. The resulting sales treatment allows the bank to remove the assets from its books and thus reduce its capital requirements.

The banking organization providing credit or liquidity support to one of these programs may have to raise funds itself in connection with these obligations to provide funds to the SPE. For example, the downgrading of the short-term deposit rating of a bank providing the credit or liquidity support could result in a simultaneous downgrading of the commercial paper issued by the SPE. In such an event, the SPE may be unable to roll over, or pay off, some or all of its outstanding commercial paper at maturity. In this circumstance, the credit deterioration in the bank providing credit or liquidity support could create a liquidity problem for the SPE. Furthermore, if cash inflows from the underlying receivables are insufficient to pay off the maturing commercial paper issued by the SPE, then the liquidity facility could be drawn down. These potential liquidity problems are exacerbated because the SEC now restricts money market mutual funds, which are major purchasers of asset-backed commercial paper, to investing no more than 5 percent of their assets in paper rated A2/P2 or worse at the time of purchase. (9)

Finally, a significant deterioration in asset quality--one exhausting the overcollateralization or recourse credit enhancements--could result in losses being absorbed by the secondary credit enhancements, usually letters of credit or cash collateral.

The liquidity or credit problems previously mentioned, in effect, could bring some portion of the SPE's assets onto the balance sheets of the banking organizations providing the credit and liquidity support enhancements. In such a case, the banking organizations providing the enhancements would have to acquire some portion of the assets of the SPE or extend credit to the SPE, both of which actions would increase the total assets of the banking organizations. This increase would adversely affect their capital ratios and certain performance ratios. Because the structures of asset-backed commercial paper programs usually differ, a case-by-case analysis of these programs is necessary to ascertain the exact nature and the extent of the risks in any credit or liquidity enhancements supporting an SPE's commercial paper.

RISK-BASED CAPITAL IMPLICATIONS FOR

ASSET-BACKED COMMERCIAL PAPER

A question arises as to whether the liquidity and credit enhancements supporting asset-backed commercial paper constitute a commitment or a direct credit substitute, that is, a guarantee of the banks providing these enhancements. The Board's risk-based capital guidelines require banks to hold less capital to support a commitment than to support a guarantee. Therefore, determining whether liquidity and credit enhancements are commitments or guarantees may affect the pricing of these off-balance-sheet obligations and, in turn, the profitability of these programs.

Under the risk-based capital guidelines, direct credit substitutes include any irrevocable arrangements that guarantee repayment of financial obligations, including commercial paper. These guidelines contain the following definition of a financial guarantee:

the combination of irrevocability with the fact that funding is triggered by some failure to repay or perform an obligation. Thus, any commitment (by whatever name) that involves an irrevocable obligation to make a payment to the customer or to a third party in the event the customer fails to repay an outstanding debt obligation . . . is treated, for risk-based capital purposes, as . . . a financial guarantee. (10)

Such-off-balance-sheet guarantees are converted at 100 percent to a credit equivalent amount on the balance sheet and then weighted according to the risk of the counterparty, after taking into account any eligible collateral or guarantees.

These direct credit substitutes or guarantees must be supported by the same amount of capital as if the obligation were held directly--as a loan--on the bank's balance sheet. The reason for this treatment is that the bank providing the guarantee faces the same credit risk as if it had a direct on-balance-sheet loan to the beneficiary of the guarantee. Thus, assuming that a loan to a borrower would be assigned a risk weight of 100 percent, a guarantee of the borrower's financial obligations would generally be assigned the same risk weight of 100 percent.

A guarantee, or direct credit substitute, is normally drawn down when the primary obligor has experienced some difficulties and therefore is unable to pay its financial obligations. A distinguishing feature of an irrevocable guarantee arrangement is that it does not customarily contain a "material adverse change" (MAC) clause or similar provision that would enable the bank providing the guarantee to escape its obligation.

In contrast to a financial guarantee, a commitment is defined for risk-based capital purposes as an arrangement that obligates, a bank to extend credit in the form of loans or leases, or to purchase loans or other assets. The important difference between a financial guarantee and a commitment is that the latter is usually drawn down in the normal course of business rather than when a party cannot meet its obligations. A commitment generally will contain provisions abrogating the lender's obligation and thus helping to limit its risk if the borrower's condition worsens. However, the presence or absence of a MAC clause or other escape mechanism has no bearing on the appropriate capital treatment.

Under the risk-based capital guidelines, if the original maturity of a commitment exceeds one year, then it is considered "long term" and is converted at 50 percent to a credit equivalent amount on the balance sheet. Alternatively, if the original maturity of the commitment is one year or less, it is considered to be "short term" and the conversion factor becomes 0 percent. Thus, a bank is not required to hold capital in support of a short-term commitment.

Backup facilities under asset-backed commercial paper programs that meet the definition of guarantees for risk-based capital purposes are to be treated as guarantees. For example, there are "commitments" that obligate a banking organization to loan against or to acquire the underlying receivables at the price paid by the SPE, regardless of the quality of the receivables or any losses on them. In this structure, the SPE would use the proceeds to retire the commercial paper. Under these arrangements, banks cannot revoke their obligation to purchase the underlying receivables, regardless of any deterioration in quality; likewise, there is generally no limit on the amount of credit loss the bank may be subject to, that is, 100 percent of the enhancement is available to absorb credit losses. Consequently, the banks providing these enhancements ultimately protect the commercial paper investors against loss by guaranteeing that the SPEs will have funds to redeem their commercial paper. Arrangements that have characteristics of a financial guarantee are regarded as direct credit substitutes for purposes of the risk-based capital guidelines. Such an agreement, even when called a commitment, should be converted at 100 percent to a credit equivalent amount on the balance sheet and generally is risk weighted at 100 percent.

In contrast, other facilities differentiate between what is potentially available to absorb credit losses and what is available to facilitate liquidity. These liquidity facilities are most commonly characterized by, at the very least, a test for some minimum asset quality that must be met before funds will be extended to the SPE. For example, funds may not be drawn against receivables of lesser quality, in other words, those in default. Therefore, these facilities could be considered commitments and may be treated as such for purposes of risk-based capital.

EXAMINER GUIDANCE

In 1990, to ensure consistency during examinations, the Federal Reserve provided guidance to its examiners to use when reviewing an institution's involvement with asset securitization transactions. Although not specifically directed toward asset-backed commercial paper programs, many aspects of these existing examination guidelines are applicable to these vehicles. For example, the guidance instructs examiners to check that a banking organization participating in a securitization transaction--whether an asset-backed commercial paper program or some other type--has clearly and logically integrated these activities into its overall strategic objectives. In addition, it states that examiners should determine that the management of the organization understands the risks associated with the various roles that the institution can assume in such programs.

Examiners are also instructed to determine that appropriate policies, procedures, and controls, including well-developed management information systems, are in place before the banking organization participates in these programs. They should ascertain that the banking organization's board of directors periodically reviews significant policies and procedures relating to these programs before approving them.

Based on this guidance, a banking operation involved in asset-backed commercial paper programs should establish overall limits on the actual amount of credit and liquidity commitments. Institutions involved in these programs should also analyze the underlying pools of receivables and the structure of the commercial paper program. This analysis should include a review of the following:

* The characteristics, credit quality, and expected performance of the underlying receivables

* The banking organization's ability to meet its obligations under the securitization arrangement.

* The ability of the other participants in the arrangement to meet their obligations.

A banking organization involved in an asset-backed commercial paper program needs to have established policies and procedures to ensure that it follows prudent standards of credit assessment and approval. Such policies and procedures would be applicable to all pools of receivables to be purchased by the SPE as well as the extension of any credit enhancements and liquidity facilities. Procedures should include an initial, thorough credit assessment of each pool for which the bank has assumed credit risk, followed by periodic credit reviews to monitor performance throughout the duration of the exposure. Furthermore, the policies and procedures should outline the credit approval process and establish "in-house" exposure limits, on a consolidated basis, with respect to particular industries or organizations, that is, the companies from which the SPE purchased the receivables as well as the receivable obligors.

For those banking organizations providing credit enhancements and liquidity facilities, an analysis of the institution's funding capabilities should be performed to ensure that these institutions are capable of meeting their obligations under all foreseeable circumstances. In addition, an analysis should be completed to determine the effects of the fulfillment of these obligations on the banking organization's interest rate exposure, asset quality, liquidity position, and capital adequacy.

Examiners, in reviewing backup lines supporting this type of commercial paper, will distinguish between guarantees and commitments. A backup arrangement is considered a direct credit substitute and, thus, is risk weighted at 100 percent if it provides credit enhancement to the asset-backed commercial paper program. In contrast, if the facility is determined to be solely for liquidity support and meets the definition of a short-term, commitment with a maturity of one year or less, as outlined in the Federal Reserve Board's risk-based capital guidelines, a zero conversion factor applies.

CONCLUSION

In recent years, commecial and investment bankers have become involved with new asset securitization programs at an increasing rate, and this trend is likely to continue. A relatively new form of securitization, asset-backed commercial paper appears to be growing in popularity, from the perspective both of the investor and of the companies using these programs for financing. To date, there are no indications that investors are reaching a point of saturation with these commercial paper issues. Rather, these issues appear to be a favored means of providing investors with a method of achieving even greater diversification of credit risk.

The market appears to be evolving in the direction of programs that involve an SPE that accommodates referrals of corporate customers from multiple banks rather than from just one institution. Also, the market seems to be moving toward having several parties provide credit and liquidity enhancements. Mechanisms such as cash collateral, which minimize the effects of a downgrade of the ratings of the associated instruments of one party, seem to be growing in popularity. These developments may limit the risks associated with asset-backed commercial paper programs.

Asset securitization activities should remain beneficial to banking organizations when conducted in a prudent manner. Banking organizations, however, must carefully evaluate the risks inherent in any new form of asset securitization and maintain appropriate controls, systems, and other measures to minimize these risks. Banking regulators will continue to review new asset-backed security structures as they develop in order to assess the associated risks to banking organizations and to the financial system.

(1) By issuing commercial paper, companies are able to secure funding directly from investors in the market instead of using banks as intermediaries and paying for their services.

(2) Other conditions that commercial paper must meet to be exempt from registration requirements include the following: The proceeds of the notes are to be used for current transactions, and the notes are not ordinarily to be advertised for sale to the general public.

(3) Marcia Stigum, The Money Market, rev. ed. (Dow Jones-Irwin, 1983), p. 626.

(4) Timothy D. Rowe, "Commercial Paper," in Timothy Q. Cook and Timothy D. Rowe, eds., Instruments of the Money Market (Federal Reserve Bank of Richmond, 1986), pp. 111-35.

(5) Evelyn Hurley, "The Commercial Paper Market," Federal Reserve Bulletin, vol. 63 (June 1977), p. 530.

(6) Thomas R. Boemio and Gerald A. Edwards, Jr., "Asset Securitization: A Supervisory Perspective," Federal Reserve Bulletin, vol. 75 (October 1989), pp. 659-69.

(7) Avi Oster and Barry Wood, "Commercial Paper: Pooled Receivables' Robust Growth," Standard & Poor's Creditweek (March 27, 1989), p. 90.

(8) Under generally accepted accounting standards and SEC reporting requirements, consolidation of the SPE is usually expected if the banking organization has a controlling financial interest in the SPE. A controlling financial interest would generally be presumed if the banking organization had a majority ownership interest in the outstanding voting shares of the SPE, although control might also be deemed to exist in certain situations involving minority ownership.

(9) In June 1991, the SEC adopted amendments to its rule 2a-7 that essentially require a money market fund to limit its total investment in securities rated A2/P2 or below to 5 percent of its assets and to limit investment in such securities of any one issuer to 1 percent of its assets.

(10) Board of Governors of the Federal Reserve System, Capital Adequacy Guidelines (Board of Governors, 1989), p. 13 and p. 41 (12 C.F.R. pt. 208, app. A. sec. III.D.1 and 12 C.F.R. pt. 225, app. A. sec. III.D.1.).

SELECTED BIBLIOGRAPHY

Board of Governors of the Federal Reserve System, Capital Adequacy Guidelines. Washington: Board of Governors, 1989.

Boemio, Thomas R., and Gerald A. Edwards, Jr. "Asset Securitization: A Supervisory Perspective." Federal Reserve Bulletin, vol. 75 (October 1989), pp. 659-69.

Cook, Timothy Q., and Timothy D. Rowe, eds. Instruments of the Money Market, 6th ed. Richmond: Federal Reserve Bank of Richmond, 1986.

Duff & Pehlps Credit Rating Agency, Performance Trend Report. Chicago: D&PCRA, Second Quarter 1991.

Duff & Phelps, Inc. Rating Approach for Asset-Backed Commercial Paper. Chicago: D&PI, March 1990.

Hurley, Evelyn M. "The Commercial Paper Market since the Mid-Seventies," Federal Reserve Bulletin, vol. 68 (June 1982), pp. 327-34.

Hurley, Evelyn M. "The Commercial Paper Market," Federal Reserve Bulletin, vol. 63 (June 1977), pp. 523-36.

Kravitt, Jason H.P., ed. Securitization of Financial Assets. Englewood Cliffs, N.J.: Prentice Hall Law & Business, 1991.

Kuhn, Robert Lawrence, ed. Mortgage and Asset Securitization. Homewood, Ill.: Dow Jones-Irwin, 1990.

Oster, Avi, and Barry Wood. "Commercial Paper: Pooled Receivables' Robust Growth," Standard & Poor's Creditweek (March 27, 1989), pp. 89-91.

Stigum, Marcia. The Money Market, rev. ed. Homewood, Ill.: Dow Jones-Irwin, 1983.