Thursday, August 30, 2007
Dull, staid commercial paper market in spotlight
SAN FRANCISCO (MarketWatch) -- Before this summer, few investors probably bothered to understand a rather staid and highly specialized part of modern financing: commercial paper.
But now, the all-encompassing term has abruptly moved into the spotlight. As mortgage lenders struggle to stay afloat and credit markets reel worldwide, even the shortest of short-term financing for business operations is facing what some view as unprecedented pressure.
"Commercial paper markets have been hurt just as much as a lot of other credit markets," said RBC Capital Markets analyst Jason Arnold.
Outstanding commercial paper fell by $62.8 billion, or 3.1%, in the week ended Wednesday to $1.98 trillion, bringing the total decline in the past three weeks to $244 billion, or 11%, the Federal Reserve reported Thursday.
Such a hit has taken place despite commercial paper's seemingly safe-haven status in lending. "It's kind of like a margin account that businesses use for short-term financing," Arnold said.
While it has been a primary source of funding for corporate mergers and acquisitions, it "can be used for almost anything," said Raymond Benton, a Denver-based adviser who purchases individual bond issues for high net-worth clients. Commercial paper is a generic term for most any short-term corporate borrowing, he added. "It's nothing more than a short-term note that can come due in as little as 30 days or less," Benton said.
Usually, such notes are backed by some sort of select group of assets. That could be anything from plants and equipment to accounts receivable.
Different industries prefer to use different types of assets for such short-term notes. "A lot of the mortgage companies were using short-term debt to act as funding to make more loans," Benton said. "That's what got them into trouble."
Besides commercial paper, companies often use reverse-repurchase agreements. "It's another short-term funding vehicle that most people have probably never heard about," Arnold explains.
With reverse-repurchase agreements, companies typically take out loans ranging from around 30 to 90 days. "Basically, they've got to put more of their own skin into the game by putting up more collateral than most other forms of commercial loans," Arnold says.
Some mortgage lenders have run into reverse-repurchase loan problems. An example is Thornburg Mortgage Asset Corp. (TMA
Thornburg Mortgage Asset Corp
Sponsored by:TMA) , Arnold points out. The Santa Fe, N.M.-based jumbo loan specialist took out those sorts of loans and then invested in mortgage-backed securities, he added.
"The reverse-repurchase market is undergoing the same liquidity crisis as commercial paper," Arnold said. "Both that [reverse-repurchases] and commercial paper are forms of collateralized borrowing on a very short-term basis. And both markets have been in a severe credit crunch this summer as availability dried up."
The practice of taking out short-term loans to fund longer-term needs works well when short-term rates are low, as they've been in recent years. "But interest rates are going up now," Benton said. "And we've had a relatively flat yield curve. That hasn't helped the situation, either."
A flat yield curve refers to a pattern in which long-term interest rates and short-term rates have been moving in similar fashion.
Despite the spreading credit crunch, short-term corporate borrowing won't go away, says John Kornitzer, chief executive of Kornitzer Capital Management, which runs $6 billion in stock and bond assets.
"Commercial credit is a very important part of our financial system," said Kornitzer, whose firm serves as adviser to the Buffalo family of mutual funds. "Normally, it's big corporations like IBM and Microsoft and General Electric issuing billions of dollars of credit every day."
Commercial paper represents where most liquid corporate assets are stashed, he added. Part of the allure is an ultra-low fee and expense structure offered to participating corporations, Kornitzer says.
"The terms can include anything less than around a year," he added. "It's like a huge, low-cost money market account for corporate America."
In the past, Kornitzer says finance executives put funds into such short-term loans "and didn't even think about it."
"Commercial paper has been a very, very stable place to stash cash for short-term needs," he said. "And it will continue to be. Companies don't invest in commercial paper to make money - they do it for safety and to earn some interest on their principal."
Problems with some mortgage lenders' portfolios and credit practices shouldn't severely blemish the commercial paper market, Kornitzer added.
"Demand and issuance are already back to more normal levels," he said. "Mortgage issuance is probably still down. But the Exxons (XOM) and Wal-Marts of the world are still going to rely on commercial paper. They're not going to let panic drive them out of a very practical and economical way to use money."
But headaches persist in anything related to mortgages.
In a note earlier this week, Lou Crandall, chief economist for Wrightson ICAP, pointed to data published by the Federal Reserve. It showed that the outstanding amount of asset-backed commercial paper fell by some 11% in the two weeks ended Aug. 22.
"Despite this shrinkage in the overall market, the amount of AA-rated ABCP rolled over in maturities of one to four days surged by 46% to a record $66 billion over the same period," Crandall said in a note.
But such data don't tell the whole story, he added. Crandall's research shows that terms and conditions are tightening in commercial paper.
"Where a dealer might have been willing to finance a customer position for a couple of months at the beginning of the summer, it might be willing to make a commitment for no more than a week or two in the current environment," he wrote.
And that situation could become more acute in coming days, Crandall added. "Customers who locked in funding through the August dog days earlier in the summer may find that the term financing market is not as deep after Labor Day as usual," he said.
Posted by Bud Fox at 4:17 PM