An update from Bloomberg tells us that commercial paper outstandings fell 4.2% in a week, which suggests the efforts of central bankers to restore confidence in that market, and particularly in asset backed commercial paper, may not be adequate.
4.2% may not sound like much of a drop until you do some quick and dirty calculations. The longest tenor of CP is 270 days. My very dim recollection from my youth is that 90 days was the most popular maturity; things could be considerably different now.
Now most issuers roll their CP, that is, issue new CP when their existing CP matures (the amount will vary a bit based on cash inflows and outflows, but that’s a decent generalization).
If 90 days is the average maturity of outstanding CP, you’d have roughly 8% maturing in any week. If you assume 45 days, then weekly maturities are roughly 16% (anyone who has real data and/or a better back of the envelope approach is encouraged to speak up).
Now you can see why a 4.2% weekly fall is a big deal. It mean that a very high percentage of maturing CP is not being rolled, forcing the issuer to go to other sources, most likely backup lines of credit, to obtain cash.
Outstanding U.S. commercial paper fell 4.2 percent, the biggest weekly drop in at least seven years, as investors fled asset-backed debt and opted for the safety of Treasuries….
The retreat may indicate that the Fed’s decision to lower the discount rate last week failed to instill enough calm to draw back investors. Commercial paper backed by assets led the fall as buyers fled debt linked to subprime mortgages. Outstanding paper may slump by a total $300 billion, representing the entire amount of debt backed by home loans, said Tony Crescenzi, chief bond market strategist at Miller Tabak & Co.
“The commercial paper market, in terms of the asset-backed commercial paper market, is basically history,” Bill Gross, manager of the world’s biggest bond fund at Newport Beach, California-based Pacific Investment Management Co., said in an interview today….
Banks worldwide have $891 billion at risk because of credit agreements on asset-backed commercial paper programs, Fitch Ratings said today.
“There is no doubt that banks have been forced to assume additional liabilities,” Gross said….
“There is a significant amount of cash in the system, it’s just not getting to the parts of the market that need it,” Conrad DeQuadros, a senior economist at Bear Stearns Cos., said in an interview today in New York….
“The shrinkage of the commercial paper market will force companies to obtain money elsewhere,” Crescenzi, who is based in New York, said in e-mailed comments today. “Some will be unable to obtain funding and will shut or scale back their operations.”
In Europe, the asset-backed commercial paper market in Europe is almost closed, Reynold Leegerstee, team managing director for Moody’s Investors Service, said on a conference call today….
The possibility of any of the large European banks defaulting on commercial paper debt is remote, Moody’s Vice Chairman Chris Mahoney said.
Note that asset backed CP is estimated to constitute half the CP outstandings, so a continued repudiation of that paper is serious indeed.
Is this good news for banks?
Presumably CP borrowers are relatively low risk and back up lines of credit are priced high enough that the borrowers have an economic incentive not to use them?
So should we assume that banks will be making some attractive risk-adjusted returns?
You’d need more data than I have ready access to in order to answer that question.
The question is whether these credit lines are adequately priced, given that the market has said that they think the collateral behind asset backed CP is no good.
Banks at least historically have regarded those lines as marginal to unprofitable (they are a plain vanilla product, usually offered not in isolation but as part of a larger banking relationship).
And I am most certainly NOT up on the terms of those agreements, but I suspect they can’t be repriced (ie, the lender can’t get a higher spread over LIBOR or other reference rate) in the absence of a ratings downgrade.