Commercial Paper Market Still in Distress

Bloomberg tells us that the commercial paper market is shrinking rapidly.

This is a more serious issue than might appear. Commercial paper is an important, if not the most important, source of short-term funding for sizable corporations, mainly because it’s cheap and flexible. They can reading adjust the amount outstanding to reflect changes in their need for cash.

When CP matures, and an issuer cannot “roll” it, as in replace it with new CP, he has two choices. If he has the option, he can draw down standby lines of credit with his friendly bank. If he has no, or insufficient, backup lines, he has to get the cash somehow.

Both option 1 and option 2 have costs. Option 1 means he is using higher-cost funding and has limited the company’s alternatives for dealing with emergencies. But more important, the demand for cash at banks means it crowds out other bank lending, such as to small businesses.

Option 2 means the company goes into crisis mode, delaying payments to vendors, trying to accelerate payment from customers, possibly even deferring payroll if that is at all an option.

Now on a small scale, these moves would create a few casualties. But on a large scale, as is happening now, both will put a damper on the real economy. They suggest that the 4% GDP growth release for the second quarter may have perilous little relevance now.

From Bloomberg:

The U.S. commercial paper market shrank for a third week, extending the biggest slump in at least seven years, as investors balked at buying short-term debt backed by mortgage assets.

Asset-backed commercial paper, which accounted for half the market, tumbled $59.4 billion to $998 billion in the week ended yesterday, the lowest since December, according to the Federal Reserve. Total short-term debt maturing in 270 days or less fell $62.8 billion to a seasonally adjusted $1.98 trillion.

Commercial paper outstanding has fallen $244.1 billion, or 11 percent, in the past three weeks, suggesting the Fed’s Aug. 17 reduction in the discount rate has yet to entice buyers back into the market. More than 20 companies and funds including Cheyne Finance and Thornburg Mortgage Co. failed to sell new paper as investors fled to safer investments.

“I don’t think the Fed understands how critical the situation is,” said Neal Neilinger, co-founder of NSM Capital Management in Greenwich, Connecticut, in an interview today. “The market is going to overshoot itself and not lend money to people who deserve it.”…

The 11 percent decline over three weeks is the biggest since 2000, according to data compiled by Bloomberg….

Commercial paper is bought by money market funds and mutual funds that invest in short-term debt securities. In asset-backed commercial paper, the cash is used to buy mortgages, bonds, credit card and trade receivables, as well as car loans. Some of the programs are backed by subprime loans. Subprime loans are issued to borrowers with poor credit or high debt.

About 26 percent of asset-backed commercial paper outstanding as of July was used to fund purchases of mortgage- related securities, according to Standard & Poor’s. The yield on the highest rated asset-backed paper due in a month reached a six-year high today of 6.18 percent….

The Fed lowered the interest rate it charges to lend to banks to encourage buyers of commercial paper after the market seized up for Thornburg, Countrywide Financial Corp. and other mortgage lenders.

The Fed “failed to bring money markets back to normal,” John Lonski, chief economist at Moody’s Investors Service in New York, said in an interview. “Credit markets are obviously in need of a rate cut.”

In a sign that buyers are still favoring safer assets, an $18 billion auction yesterday for two-year U.S. government debt drew the most demand since 1992.

The sale drew $3.97 for every $1 sold, the most since at least 1992, according to Bloomberg data. For the past 12 sales, the bid-to-cover ratio has averaged $2.77…..

The Federal Reserve Bank of New York said last week that it is accepting “investment quality” asset-backed commercial paper as collateral for loans. The central bank cut the discount rate, or the interest rate it charges banks, by 0.5 percentage point on Aug. 17 to increase demand for securities.

Futures as of yesterday show traders see a 46 percent chance the Federal Reserve will cut its target rate for overnight lending between banks to 4.75 percent at its Sept. 18 meeting.

“We need to get the banks to start lending again,” Plaut said. “Once we see that, we’ll start to see the positive impact on the financial markets.”

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3 comments

  1. Anonymous

    You missed a bit or an update..

    “The fall was the slowest of the past three weeks, following the two previous declines of about $90 billion each. Outstanding paper for financial companies, not asset-backed, rose for the first time in five weeks by $3 billion to $781.5 billion.

    “There’s a little better functionality and if there is any glimmer of hope, that’s where we’re finding some,” said Kevin Flanagan, fixed income strategist at Morgan Stanley “

  2. Yves Smith

    Thanks for the additional information. However, the point remains that CP outstandings are still falling, even if the rate of decline has slowed. The ABCP sector is still in distress.

    The rise in outstandings in the financial, non-ABCP could be related to the use of backup lines above, that some of that is being funded out. Or, more likely, it’s noise. And a weekly rise of $3 billion is roughly 1/20 the level of decline in ABCP last week of nearly $60 billion, which as you noted was better than the preceding two weeks.

    If that’s the only good news they can find, it’s indeed a glimmer.

  3. Anonymous

    Well a pertinent question is why should/ would anyone re-fund an 10x levered ABCP issuer that has been messing around in the CDO MBS mkt?

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