The Economist
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 Posted: Mon, Aug 20 2007, 8:28 pm EDT Post subject: Funding difficulties: A conduit to nowhere |
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Funding difficulties
A conduit to nowhere
Aug 16th 2007 | FRANKFURT AND LONDON
From The Economist print edition
Even conservative banks are rumbled by risky credit-arbitrage funds
MANY banking crises have had their roots in property: America's in 1988, Sweden's in 1992, Germany's earlier this decade. What is strange about the latest turmoil is that some of the biggest losses for banks have come to light far from America's subprime-mortgage market where they began. In February HSBC, a British bank, was one of the first big institutions to acknowledge steep losses in underwriting loans to Americans with poor credit scores. Six months later, a German bank, IKB Deutsche Industriebank, came close to failure because of its exposure to securities backed by the same sort of American loans.
On August 13th it was Canada's turn to take centre stage in the drama, when Coventree, a niche Canadian investment bank, declared it was seeking liquidity funding of up to C$700m ($660m). The same day, 17 other Canadian funds sought to secure bank credit-lines. Coventree claimed some of its liquidity providers had refused to provide needed cash, without specifying who they were. The next day Coventree's shares soared after it said it had found funding.
As the problems have spread, analysts have turned their attention to other Canadian banks, American banks like Citigroup, German Landesbanks—wholesale banks, such as WestLB and SachsenLB—and large British groups like Lloyds and HBOS. The worries have dragged down the world's stockmarkets (see chart).
Concerns are focused on investment vehicles, known as conduits, which are mostly kept off banks' balance sheets and are funded in the asset-backed commercial-paper (ABCP) market. The loans are typically cheap, usually roll over every few months, and are used to buy highly rated, but high-yielding assets, such as collateralised-debt obligations. The risk of using short-term funding was always one of liquidity—and it dried up quickly once lenders became spooked. With triple-A rated assets, that had not been expected to become a problem. But the malaise spread to the sponsoring banks that typically provide “temporary” back-up credit.
Conduits have been hugely popular in both North America and Europe, partly because their high ratings may eventually enable banks to reduce their regulatory capital and partly because they pay far better than, say, similarly rated American Treasuries. The first sophisticated conduits were established around 1998 by BayernLB and WestLB, two German Landesbanks. By the end of March some $507 billion of ABCP assets were in European conduits, according to Citigroup. The global ABCP market is estimated at $1.2 trillion, up from $650 billion three years ago.
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