Rate Cut Gives Little Relief to Commercial Paper Market

Despite the lift the Fed’s rate cut gave to the stock and corporate bond markets, the commercial paper market remains in distress.

While CP outstandings are still falling, which is not good, particularly given this month’s maturing CP is much greater than last month’s, the level of decline is not as severe as during the last three weeks in August, when outstandings fell a total of $244 billion over that period. Nevertheless, one would have expected the rate cut to reverse the shrinkage in the commercial paper market.

Given that failure to roll maturing CP often results in issuers drawing on backup lines of credit, the tsuris in the money markets puts pressure on banks and competes with other uses of bank lending capacity. However, analysts speculate that some issuers, expecting a slowing economy, may be selling less CP.

From Bloomberg:

The U.S. commercial paper market shrank for a sixth week, extending the biggest slump in at least seven years and signaling Federal Reserve interest-rate cuts haven’t yet drawn investors back to short-term debt.

Short-term debt maturing in 270 days or less fell $48.1 billion in the week ended yesterday to a seasonally adjusted $1.87 trillion, including a $32.1 billion decline in financial firms’ commercial paper. Asset-backed debt dropped $15.6 billion, according to the Fed in Washington.

Commercial paper investments have declined $354.5 billion, or almost 16 percent, since the week ended Aug. 8, according to the Fed. The slump began in asset-backed paper and spilled into financial companies’ short-term debt. Banks and other financial institutions have sold almost $14 billion of bonds and notes since Aug. 24, allowing them to pay off commercial paper…..

The prospect of a slowing economy, which prompted the Fed to act this week, may have caused firms to reduce sales, said Tony Crescenzi, chief bond market strategist at Miller Tabak & Co. in New York.

“The economy is not very strong,” Crescenzi said. That reduces the need for banks and brokerage firms to sell new debt to fund their day-to-day activities, he said. “The demand for money weakens when the economy weakens.”,,,,

Financial issuers are selling longer-term debt and avoiding the risk that commercial paper won’t roll over when it matures, said James Cusser, who manages about $1.5 billion in fixed-income securities at Waddell & Reed Inc. in Shawnee Mission, Kansas.

“Financial companies may be willing to forgo all the advantages of commercial paper as long as the market is stable because they haven’t seen a liquidity event like this before,” Cusser said. The banks and brokerage may keep paying off commercial paper “until the clouds pass.”

The buyers’ freeze shut out borrowers including mortgage lenders Countrywide Financial Corp. and Thornburg Mortgage Inc. as well as GMAC LLC and investment company Cheyne Finance Plc.

GMAC, the lender owned by Cerberus Capital Management LP and General Motors Corp., last week accepted $21.4 billion in financing from Citigroup Inc. after being unable to sell commercial paper. Calabasas, California-based Countrywide borrowed its entire $11.5 billion in available bank credit lines last month to fund its operations after being unable to roll over its short-term debt.

“It’s more of a supply issue than demand,” said Peter Crane, founder of Crane Data LLC, the Westborough, Massachusetts- based publisher of the Money Fund Intelligence Newsletter. “People would buy it, but issuers don’t want to issue at the price.”

Asset-backed commercial paper sellers use the cash to buy mortgages, bonds, credit card and trade receivables, as well as car loans. Because some of the programs are backed by subprime loans, where defaults had reached a five-year high, investors refused to buy the debt.

The view that purchasers of asset-backed commercial paper have driven the drop by boycotting the paper completely is a “myth that needs to be dispelled,” Maureen Coen, global head of asset-backed commercial paper origination at Credit Suisse Group, said at conference in New York yesterday.

“We all could have predicted exactly the dollar amount of decline frankly,” she said, because it was driven by exits by issuers that were forced due to program rules such as declines in the values of holdings, or that were voluntary because borrowing costs were higher in the market versus other sources of short- term debt.

Outstanding asset-backed commercial paper has slumped $253.4 billion. The declines slowed each week from a peak of $77.1 billion in the week ended Aug. 22. Sales have declined as investors balked at buying some commercial paper, shutting out some issuers.

“This means there are still players being escorted from the market,” Crane said.