Asset-backed commercial paper is a short-term investment that uses the assets of the issuing company as collateral, making it less risky than other investments. It can be a collateralized debt obligation or a collateralized mortgage obligation, and government-sponsored companies are some of the largest issuers. During a credit crunch, the government may create funds to provide liquidity to companies that cannot issue commercial paper.
In investment, asset-backed commercial paper refers to investments that use the assets of the issuing company as collateral. These are typically short-term investments, with maturities of nine months or less. Like all commercial paper, asset-backed commercial paper is generally discounted or priced below face value. When the paper matures, the investor who bought it gets the par value. The difference between the discounted sales price and the face value of the investment represents the investor’s return. Because they are backed by the assets of the issuing company, they tend to be less risky than other types of investments.
Asset-backed commercial paper could be a collateralized debt obligation (CDO) or a collateralized mortgage obligation, or CMO. Each of these instruments is backed by a set of assets with different levels of risk. A CDO is usually backed by bonds or loans. A CMO is backed by mortgages. By using a variety of assets, risk is spread across the entire group, reducing the impact of potential default on any one loan. A CDO or CMO is known as a transfer guarantee, since the loan payments, after deduction of fees, are passed on to investors.
In the United States, government-sponsored companies are some of the largest issuers of asset-backed commercial paper. The Federal National Mortgage Association, also known as FNMA or Fannie Mae, issues CMOs that it guarantees. Federal Home Loan Mortgage Corp., sometimes called FHLMC or Freddie Mac, also creates and guarantees mortgage-backed securities. The National Government Mortgage Association, also called GNMA or Ginnie Mae, does not issue CMOs, but guarantees them. A Ginnie Mae bond is backed by the full faith and credit of the US Government, making it a virtually risk-free investment.
When an economy experiences a credit crunch, such as the United States in the fall of 2008, it may be difficult or impossible for a company to issue asset-backed commercial paper. Since commercial paper is often used to finance a company’s day-to-day operations, this type of credit crunch can severely affect a company’s ability to do business. When this happened in the United States in 2008, the government created the Commercial Paper Financing Fund, or CPFF, to provide liquidity to companies that could not issue the commercial paper they needed. Longer-term investments received similar treatment from the Money Market Investment Fund, or MMIFF. The Primary Dealer Facility of Credit, or PDCF, was also created to allow dealers to borrow overnight with sufficient collateral.
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