07 September 2007

Banks' Commercial Paper Premiums Hit Record

Bloomberg, Doug Alexander, 7 September 2007

Bank of Montreal, Royal Bank of Canada and other Canadian banks are paying record interest-rate premiums to get investors to buy their asset-backed commercial paper amid a meltdown in U.S. subprime mortgages.

The rates for the banks' 90-day commercial paper are as much as 5.6 percent, or 60 basis points higher than benchmark rates, said traders and investors including Edward Devlin at Pacific Investment Management Co. The difference, or spread, was about 2 basis points a month ago. A basis point is 0.01 percentage point.

``Markets are simply about greed and fear, and right now they're about fear over greed,'' said Devlin, a portfolio manager at Newport Beach, California-based Pimco, which manages the world's largest bond fund.

The soaring spreads show how the commercial paper crisis has shifted to Canada's banks from non-bank issuers such as Coventree Inc., even though the bank-sponsored funds have almost no investments in U.S. subprime mortgages. The rising rates may erode bank earnings if they're sustained, said Devlin, who helps manage $692.7 billion at Pimco.

``The banks are going to suffer from higher funding costs,'' he said.

Commercial paper spreads widened after Toronto-based Coventree and other non-bank funds, or conduits, failed to roll over most maturing commercial paper in mid-August because investors were concerned about possible links to mortgages made to people with poor credit.

Unlike commercial paper issuers in the U.S. and elsewhere, Canada's non-bank funds were unable to turn to banks for emergency funds to refinance maturing debt. That's because the banks that committed to back these trusts only have to do so in the case of a ``market disruption,'' according to criteria used by rating company DBRS Ltd.

The C$35 billion ($33 billion) market for non-bank paper froze as a result, prompting 10 banks and money managers, including Deutsche Bank AG and Barclays Bank Plc, to convert the paper into longer-term debt.

Canadian banks have said the market for their own paper, which accounts for about two-thirds of the C$120 billion asset- backed market, hasn't stalled, and they've been able to roll over the debt when it comes due.

The banks said their paper is largely backed by investments such as credit-card bills and car loans, instead of subprime loans. The soaring interest rates suggest investors aren't listening, steering clear of all commercial paper, regardless of what assets are backing them.

``No one likes ABCP anywhere right now,'' said Huston Loke, an analyst at DBRS in Toronto. DBRS is the main rating company for asset-backed commercial paper in Canada.

Toronto-Dominion Bank has no subprime investments in its asset-backed commercial paper conduits, said spokesman Simon Townsend. Nor does Royal Bank, spokeswoman Katherine Gay said. Bank of Montreal has no U.S. subprime investments in its Canadian bank-sponsored commercial paper, spokesman Ralph Marranca said. CIBC declined to comment as did Bank of Nova Scotia spokesman Frank Switzer. The five banks are based in Toronto.

``The market has yet to clearly draw distinctions between bank-sponsored and non-bank sponsored programs in Canada,'' Gay said. ``The former does not have the fundamental problems that are causing a drop in market confidence, but can't help but be affected by the general spread widening.''

Bank of Montreal had the biggest market share among Canadian banks in the asset-backed commercial paper market as of June, followed by CIBC, Toronto-Dominion, Royal Bank and Bank of Nova Scotia, according to DBRS.

``Even though the yields are pretty juicy, nobody wants to be left holding the bag even if you've got a very rock-solid program,'' Pimco's Devlin said. Pimco is a unit of Munich-based Allianz SE.

The banking industry ``is not sustainable'' if they're funding at yield spreads 50 basis points above the bankers' acceptance rate, Devlin said. The bankers' acceptance rate is the benchmark for the commercial paper market.

``Banks right now are still caught in the same situation that everyone is, globally, where there's a crunch and anything with any risk on it is looked at with disdain,'' Loke said. ``This has been unprecedented in terms of not only the spread at which things are trading, but also the credit environment.''

Banks ``may be experiencing some losses if they are having to roll over paper and pay rates'' that are unprofitable, Dundee Securities analyst John Aiken said in an interview from Toronto. ``But this is something that is hopefully transitory.''

The 90-day bankers' acceptance rate, which banks charge each other for short-term loans, has also risen to 4.96 percent in Canada, from 4.63 percent on July 3.

Banks that continue issuing asset-backed commercial paper may simply pass on the higher costs by charging more for loans, Aiken said.

``A month from now it may cost you a lot more to get an auto loan, even if there's no change in interest rates,'' he said.

Pimco hasn't been a buyer of bank-sponsored asset-backed commercial paper in Canada, Devlin said.

``Obviously at these levels, they're starting to look more interesting,'' he said.