Capital Markets

Commercial Paper Shows Signs of Life

Yields on the short-term have dipped since the Fed announced its backstop plan.
Alan RappeportOctober 10, 2008

The emergency global interest rate cuts and a move by the Federal Reserve to buy corporate commercial paper appear to have loosened up the market for short-term debt sales.

Yields on the highest-rated one-day commercial paper placed by dealers Thursday declined 1.15 percentage points to 2.35 percent, Bloomberg News reported. Also, the wire service said, Sears Holdings reduced its offer rate 1 percentage point to 3 percent, and HSBC lowered the rate it is willing to pay by 0.25 percentage points to 2 percent.

Commercial paper can carry maturities of up to 270 days, but as the credit crisis has worsened most investors have been willing to buy only overnight paper. According to the Federal Reserve, U.S. commercial paper offerings dropped $264 billion during the past four weeks and fell $56.4 billion, or 3.5 percent, to a seasonally adjusted $1.55 trillion for the week ending Oct. 8.

“The bleeding has stopped,” Tony Crescenzi, the chief bond market strategist at Miller Tabak in New York, said in an interview on Bloomberg Television. “It’s very vital and it’s a market that seems to be showing signs of life.”

Meanwhile, interest rates on overnight commercial paper issued by AA-rated financial companies averaged 1.71 percent on Thursday, down from 2.59 percent on Wednesday, according to data released by the Fed. The average rate on overnight paper sold by AA-rated non-financial companies fell to 1.52 percent from 2.27 percent on Wednesday. And the overnight rate on asset-backed commercial paper averaged 3.97 percent, down from 5.07 percent on Wednesday.

On Tuesday the Fed revealed a plan for a “funding backstop” to U.S. issuers of commercial paper through a special purpose vehicle. The SPV will buy three-month unsecured and asset-backed commercial paper directly from eligible issuers. The Fed will finance the SPV with the help of the Department of Treasury.

The SPV will buy from U.S. corporations three-month, asset-backed paper with sufficiently high ratings (at least A1/P1/F1 by a major rating agency). For paper that’s not asset-backed, firms will need to find other ways to secure it with the Fed. Although it is still sorting out which of the different methods are acceptable, the Fed suggested that firms will need to pay an upfront fee, obtain a guarantee for its obligations, or provide collateral or some other type of security that satisfies the Fed.

The maximum amount of commercial paper a single issuer will be able to sell to the SPV will be equivalent to the average amount it had outstanding in August 2008, less any amount outstanding held by investors. The SPV is slated to stop buying commercial paper on April 30, 2009, and the Fed will continue to fund it until the underlying assets that it holds mature.