After a long slide, the commercial paper (CP) market appeared to perk up this summer. The amount of CP outstanding, which peaked at $2.2 trillion in 2007, hit a low of $1.042 trillion dollars this June, then rose some $70 billion over the next six weeks, to $1.1 trillion. Optimists began to speculate that the downward trend was over. But the Federal Reserve's data for the week ended Aug. 25 showed the CP market had slipped about $25 billion, to $1.087 trillion. Is the CP market signaling that the economy is dipping back into a recession?
Actually, it's a case of two steps forward, one step back, says Robert Little, head of global short-term fixed-income origination at Bank of America Merrill Lynch. Despite the fluctuations, "the market has stabilized," he says. "We're not seeing [significant] contraction."
Little cites several reasons for a positive view of the CP market. "First, as the outlook for the economy improves you'll start to see a pickup in M&A and more companies using CP as a bridge financing tool for acquisitions," he says. "Secondly, companies will build more inventory and as a result there will be a need to issue more short-term debt" to finance that inventory.
And now that the Fed is perceived to be on hold on interest rates for some time to come, high-quality corporations may choose to fund in the commercial paper market rather than issue any more longer-term debt since they're not concerned that the term debt market is going to move away from them, Little notes. Companies may increase their short-term or floating-rate borrowings to take advantage of the interest-rate environment, he says.
Still, this is not the commercial paper market of yesteryear, notes Capital Advisors Group's Lance Pan. The era of high-octane, off-balance-sheet special investment vehicles (SIVs) fueling the asset-backed commercial paper market is gone forever, given changes in the regulatory regime and the treatment of SIVs. "Balances in the [asset-backed] area will continue to go down," says Pan. "It's the banks' preference to let that business run down."
Another lasting structural change is the increased preference of money market funds for shorter paper--a shift driven by new Securities and Exchange Commission rules on liquidity. "Ideally, corporations would like to issue 30-, 60- or 90-day paper," says Brian Kalish of the Association for Financial Professionals, rather than seeing their paper constantly roll over. He notes that so far in 2010, one- to four-day paper has comprised 74% of non-asset-backed commercial paper issuance, compared with just 60% in 2008. Companies have to satisfy investors, says Kalish. "The appetite for the longer-days paper has gone away."