Commercial Paper
Jim Kelly
BA543-002
May 12, 2005
What to Expect (all in 20 Minutes)
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Definition
A Brief History
The Contemporary Commercial Paper
Issuers and Dealers
Buyers
Credit Ratings
Recent Innovations
Foreign Markets
Concluding Remarks
Answer A Few Insightful Questions
What is Commercial Paper?
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Unsecured, Negotiable Promissory Note
Made Payable on a Stated Date
Typically Issued at a Discount
Short-Term: Maturity of 3 to 270 Days in
the U.S.
• Does Not Require SEC Registration
• Maturity < 90 Days; Collateral for the
Federal Reserve
A Brief History Lesson
• Colonial Commercial Paper: The Yanks
and the Sox (See Map)
• 1840s: Interest Rates First Published
• The Reconstruction
• The Panic of 1907
• The Great Depression
• The Post-War Boom
• Penn Central Crisis of 1970
• Mercury Finance Company Default of 1997
The Contemporary Commercial
Paper Market
• Average Maturity of Commercial Paper =
30-35 Days
• Small Secondary Market
• Most Issuers (At Their Discretion)
Continuously Roll Over Debt
• Sold in Large Denominations
• Commercial Paper Rates
– 1½% to 3% Below the Prime Rate
– 1/8% to ½% Above the T-Bill Rate
Contemporary Market –
Recent Growth
• Explosive Growth in Commercial Paper
Outstandings (12% CAGR):
– 1981: $160B
– 1991: $530B
– 2001: $1,530B
• Federal Reserve CP Statistics
• Chart of Nonfinancial CP Outstandings
Issuers
• Finance Companies
– GMAC
– GE Capital
– Ford Motor Credit
– Merrill Lynch
– JP Morgan
– PepsiCo
• Short-Term Needs and a Very High
Credit Rating
Intermediaries
• Investment Banks and Commercial Bank
Holding Companies Place More Than 70%
of all CP. The Big Three Investment
Banking Firms Are:
– Goldman Sachs
– Lehman Brothers
– Merrill Lynch
• Underwriting Spread of 5 to 10 Basis Points
• Internal Sales Forces
Buyers and Consumers
• CP is a Highly Liquid, Low Risk Asset (See
Chart)
• Money Market Mutual Funds (1/3 of All CP)
• Commercial Bank Trust Departments (1/4
of All CP)
• Industrial Firms
• Insurance Companies
• Colleges and Universities
• Large Corporations
Creditworthiness
• Credit Ratings Issued by A Credit Agency
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Standard and Poor’s
Moody’s
Duff and Phelps
Fitch
• Almost All Issuers Maintain 100% Backing
Through Bank Lines of Credit
• Credit Enhancements Are Leased from
Higher-Rated Firms
Credit Ratings
• Strong Correlation Between Commercial
Paper Debt Ratings and Term Debt Ratings
• Somewhat Archaic System (Credit Cliff)
Term Rating
Term Ratings
Outstandings
CP Rating
CP Ratings
Oustandings
AAA to A
68%
Tier-1
88%
A- to BBB
20%
Tier-2
7%
BBB- and
lower
10%
Tier-3 and
lower
4%
Unrated
2%
Unrated
1%
Recent Innovations
• Asset-Backed Securities
– Special-Purpose Entities (SPEs) or Special Purpose
vehicles (SPVs)
– Moving Assets and Liabilities Off the Corporate Balance
Sheet
• FASB Does Not Require the Disclosure of OffBalance Sheet Activities
• Highly Rated Asset-Backed Paper is an Easy Sell
• “Independence Day” Financed Through CP Tied to
Film Receivables
Foreign Markets
• European Commercial Paper Market
– Longer Maturities Due To Different
Regulatory Environment
– Active Secondary Market
– Higher Default Rate
– Dealers Play a Much More Active Role
• Japan
• France
Concluding Remarks
• Growth in Commercial Paper Signals
Decreasing Role of Commercial
Banks in Corporate Financing (See
Chart)
• Higher Interest Rates Increase Activity
• No Significant Defaults Since 1970;
The Market is Untested
• Still a High Reliance on the Banking
System for Insurance
Questions?