The Commercial Paper Market: Headwinds and Bright Spots | Practical Law

The Commercial Paper Market: Headwinds and Bright Spots | Practical Law

According to recent data from the Federal Reserve, the commercial paper market has contracted to about half its July 2007 peak of $2 trillion. The euro zone crisis, economic weakness in the US, and the availability of low-interest, long-term loans and bonds have all served to chill the commercial paper market.  However, according to a report by Fitch Ratings, certain borrowers that traditionally have not been significant issuers of commercial paper are increasingly using commercial paper to satisfy short-term funding needs.  

The Commercial Paper Market: Headwinds and Bright Spots

Practical Law Legal Update 0-513-4457 (Approx. 3 pages)

The Commercial Paper Market: Headwinds and Bright Spots

by PLC Finance
Published on 21 Nov 2011 • USA (National/Federal)
According to recent data from the Federal Reserve, the commercial paper market has contracted to about half its July 2007 peak of $2 trillion. The euro zone crisis, economic weakness in the US, and the availability of low-interest, long-term loans and bonds have all served to chill the commercial paper market. However, according to a report by Fitch Ratings, certain borrowers that traditionally have not been significant issuers of commercial paper are increasingly using commercial paper to satisfy short-term funding needs.
According to recent data from the Federal Reserve, the commercial paper (CP) market has contracted to about half its July 2007 peak of $2 trillion. Several factors continue to chill CP market sentiment:
  • Euro zone sovereign debt crisis. Due to the uncertainty caused by the crisis in the euro zone, investors are wary of purchasing commercial paper issued by banks exposed to euro zone sovereign debt or other companies located within the euro zone. Because new issues of CP from high-quality domestic borrowers are insufficient to satisfy investor demand, investors have sought CP from banks and other corporate issuers outside of the euro zone, which they regard as safer alternatives.
  • Domestic economic weakness. Because of the current weakness in the US economy, many domestic corporations do not need the short-term capital that CP offers as inventory levels remain low and firms are reluctant to hire new workers.
  • Low rates on loan and bond financing. Many domestic borrowers have taken advantage of low interest rates on long-term loans and corporate bonds to meet their financing needs and therefore do not need to access short-term funding by issuing CP.
However, according to a report published by Fitch Ratings on November 21, 2011, CP issuance by so-called Tier 2 borrowers, which has not historically accounted for a significant proportion of the CP market, has grown steadily in recent months. According to Fitch, while highly rated Tier 1 companies continue to dominate the CP market:
  • Tier 1 CP has declined by 10% since the end of 2010 (from $857 billion to $771 billion).
  • Tier 2 CP has grown by 82% over the same period (from $38 billion to $69 billion).
CP investors see Tier 2 CP as attractive short-term investments when compared to near-zero interest rates on short-term Treasury obligations and the contagion risk associated with CP issued by banks that may be overly exposed to euro zone sovereign debt. As investors have increasingly turned away from financial sector CP, the proportion of the CP market that consists of non-financial paper has continued to rise. However, in a market dominated by banks and asset-backed paper, corporate CP still accounts for only about 20% of the overall CP market.
As investors continue to limit their exposure to financial sector CP, Tier 2 issuers, many of which have low leverage levels and good liquidity positions, look set to benefit from continued interest from CP investors, which will likely exert downward pressure on the short-term borrowing costs for these non-traditional CP issuers.
For more information on commercial paper, see Practice Notes, Debt Securities: Overview: Commercial Paper and US Commercial Paper Programs: Overview.