naked capitalism

One of the most troubling aspects of the credit crunch is that even large companies are now seeing its effects. By way of background, the commercial paper is a significant source of short-term funding for big companies and financial firms. Commercial paper is unsecured IOUs (there is another type of commercial paper, “asset backed commercial paper” but we are focusing here on the traditional, plain vanilla kind). CP can go out as long as 270 days, but the bulk placed is 30 to 90 days.

When Lehman failed, losses on its commercial paper led the money market fund Revere to “break the buck”, that is, go lower than its promise (but not guarantee) to manage its holdings so as to maintain a $1 net asset value per share. That is key because money market funds are widely viewed by consumers as an alternative to bank deposits.

Consumers and institutional money market investors began moving funds out of regular money market funds into Treasuries or government bond money market funds. Even though the Treasury program to offer insurance to money market funds stopped the run, the amount now held by non-government money market funds has contracted significantly. Since they are big buyers of commercial paper, this has reduced the size of the pool available to invest in CP significantly.

The first update comes from Bloomberg:

Interest rates on three-month dollar loans rose to a nine-month high, short-term corporate borrowing fell by the most ever and leveraged loans tumbled, exacerbating the credit freeze that’s paralyzing businesses around the world.

The London interbank offered rate that banks charge each other for loans rose for a fourth day…..The biggest drop in financial short-term debt outstanding since at least 2000 caused the U.S. commercial paper market to tumble 5.6 percent to a three-year low, according to the Federal Reserve.

The crisis deepened after the worst month for corporate credit on record. Leveraged loan prices plunged to all-time lows, short-term debt markets seized up and even the safest company bonds suffered the worst losses in at least two decades…

The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, widened as much as 25 basis points to 3.6 percentage points, the highest since Bloomberg began compiling the data in 1984. The spread is currently at 3.53 percentage points.

Rates on three-month Treasury bills fell 12 basis points to 0.68 percent. The bills touched 0.02 percent on Sept. 17, the lowest since the 1940s, as the bankruptcy of Lehman Brothers Holdings Inc. sparked a run on the safest securities.

Interbank rates have soared as financial institutions hoard cash to meet future funding needs amid deepening concern that more banks will collapse. Governments in Europe and the U.S. rescued six financial institutions in the past week. The Libor- OIS spread, the difference between the three-month dollar rate and the overnight indexed swap rate, widened to a record 260 basis points today. It was 197 basis points a week ago and 79 basis points a month ago.

Libor for euros advanced 3 basis points to a record 5.32 percent. Libor, set by 16 banks in a daily survey by the British Bankers’ Association, is used to set rates on $360 trillion of financial products worldwide, from home loans to derivatives.

“We still see upward pressure on maturities from one week,” said Patrick Jacq, a fixed-income strategist in Paris at BNP Paribas SA, France’s biggest bank. “The situation is still blocked and we’re unlikely to see spreads decline before confidence has been restored.”

The market for commercial paper plummeted $94.9 billion to $1.6 trillion for the week ended Oct. 1 as banks and insurers were unable to find buyers for the short-term debt amid the worst U.S. financial crisis since the Great Depression. Financial paper accounted for most of the decline, plunging $64.9 billion, or 8.7 percent, to a two-year low.

The market dropped for a third straight week, losing a total of $208 billion, as money-market funds faced withdrawals from investors, said Tony Crescenzi, chief bond market strategist at Miller Tabak & Co. in New York.

“The purge is broad and is impacting issuers with far more predictable cash flows — regular run-of-the-mill companies in need of working capital,” Crescenzi wrote today in a note to clients. “The declines add to the urgency for fixes to the credit crisis and bolster the case for a Fed rate cut.”

The U.S. market for short-term debt backed by assets including mortgages and car loans fell $29.1 billion, or 3.9 percent, this week to a seasonally adjusted $724.7 billion, according to the Fed.

While banks, brokers and insurers have struggled to issue commercial paper, non-financial companies such as Caterpillar Inc. and Fairfield, Connecticut-based General Electric Co. have had less trouble. The market for non-financial issuers of the debt was little changed this week at $199.1 billion after rising to an almost seven-year high last week of $217.2 billion, the Fed data show….

Lenders are balking at offering cash for longer than a day even as central banks pump an unprecedented amount of money into the banking system…

Leveraged loan prices tumbled 8.57 cents in September to a record low of 79.8 cents on the dollar. Price declines will make it harder for junk-rated companies to borrow as investors may opt to buy existing debt at distressed levels and as capital- constrained banks restrict lending.

Corporate bonds with the highest AAA ratings lost 6.5 percent in September, the most since at least 1989, according to Merrill Lynch & Co.’s U.S. Corporates, AAA Rated index.

And more from Tony Crescenzi vie RealMoney ($, hat tip reader Michael):

The commercial paper market had been relatively stable since contracting sharply a year ago, and in recent weeks it had seen strong increases in the total amounts outstanding, so this latest decline marks an abrupt shift. Reflecting the drying up of credit availability in the commercial paper market, commercial paper rates have surged. For example, the seven-day rate for asset-backed commercial paper has jumped to 4.50% from the roughly 2.5% rate that had prevailed over the past few months. A continuation of this trend would be problematic for the economy, as the commercial paper market is where entities go to raise working capital to produce goods and services….

…issuers with mortgage-related exposures have been pushed out of the market, and this is what makes this latest round of seizing up worrying, because the issuers that remain are considered far more stable entities with more predictable cash flows.