Liquidity puts November 22, 2007 at 7:50 am

It seems from FT alphaville that liquidity puts are not that well known. Here’s the gig. In any structure where a vehicle issues paper backed only by collateral (such as a SIV, conduit or securitisation) but where the paper has a shorter duration than the collateral, there is liquidity risk: if no one buys the paper, the issuer can have a problem regardless of solvency. To protect against this liquidity risk, many sponsors have bought liquidity lines, aka liquidity puts. Typically the issued liabilities are ABCP, and the liquidity put is an undertaking from a large well-rated and liquid bank that if the CP market does not want the issuer’s paper then (providing it is solvent) the bank will either buy the paper or lend the issuer money. This loan is often contingent on a general disruption in the CP market, and this type is also known as a backup CP line.

This structure was commonplace and many SIVs, conduits and other securitisation SPVs enjoy some form of liquidity support from a major bank. The problem is, as I noted earlier, many of these backup lines have been or will soon be triggered. You wrote it liquidity, you own it.

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