Corporate Corner: A Different Approach to Commercial Paper

Thomas Bausano
Thomas Bausano Managing Director, Mizuho Americas Debt Capital Markets
November 4, 2016

Despite its size and importance for corporates, the commercial paper markets are typically a low profile corner of the capital markets and rarely get much press. The notable exceptions are during times of financial stress where the commercial paper market suffers dislocations marked by higher cost of issuance and diminished market capacity. Although most of these episodes have been very short in duration (weeks), the disruption following the Lehman Brothers collapse in 2008 was pronounced enough to prompt the SEC to implement money market fund (MMF) reforms.
By way of background, commercial paper is an unsecured short-term debt instrument used by corporates and financial institutions to manage working capital, such as financing account receivables, inventory management, and meeting other short term liabilities. The instrument is distributed by a commercial paper dealer, such as Mizuho Securities USA, Inc., on behalf of the company and is essentially a promissory note to be repaid by the borrower. It does not have a coupon payment like most longer-term debt instruments, and is typically issued at a discount to face value (and repaid at par) with the implicit interest rate reflecting prevailing market interest rates such as LIBOR, Fed Funds, and Bank CD Rates. The maturity of commercial paper ranges from overnight out to 397 days (with most of the market issuing at less than one month) and as such is not required to be registered with the SEC.  Investors or buyers of commercial paper are banks, mutual funds, brokerage firms, corporates and money market funds. As an unsecured debt instrument, issuers are large and highly rated investment grade companies and, in order for the program to be rated, the borrower must demonstrate they have adequate backstop liquidity (most common is an unfunded revolving credit facility) to support their outstanding balances. The commercial paper market is therefore an essential financing tool for corporates as it is a very low cost and flexible source of capital. For context, outstanding commercial paper is approximately one trillion dollars, of which the non-financial corporate balance is roughly $270 billion.
The new set of SEC rules was designed to address potential financial instability caused by MMFs. The key elements of the money market fund reforms that went into effect on October 14th are: 1) the establishment of three categories of MMFs – retail, government and prime institutional; 2) restrictions on who is allowed to invest in retail MMFs; 3) requirement of institutional funds to have floating net asset values (NAV) like other mutual funds (retail and government funds still target a stable $1 NAV); and 4) allows certain funds to impose liquidity fees and temporarily suspend withdrawals (known as gates) in certain circumstances. The most notable market reaction to the new rules has been a shift away from the prime money market funds that invest corporate commercial paper to government-only strategies, which still maintain a stable NAV and avoid the gates and fees associated with prime funds – these funds have lost approximately a trillion dollars in assets over the course of the last year. The other significant market response has been the dramatic move higher in 3M LIBOR rates, which has climbed to 88 bps. While part of the move can be explained by increased market expectations for another rate hike by the Federal Reserve, it has also been caused by the movement of these funds out of prime and into government-only MMFs. What is important for non-financial corporates is that pricing and capacity have been mostly unaffected by this regulation, which further supports our strong belief that commercial paper is a stable and consistent source of liquidity that can be a core component of a company’s capital structure.
We have a differentiated approach to our commercial paper dealership that leaves us well placed in the market at a time when other dealers have de-emphasized or, in some instances, terminated their commercial paper businesses. We concentrate our capital and the resources of our originators and traders on the corporate clients of our bank rather than trying to chase volume with non-clients, such as other competitor financial institutions that comprise a larger component of the overall market. As a result, our desk has more time and resources to advise issuing clients on how they go to market and manage their outstanding commercial paper balances. In addition, with better insights from the issuers, we are able to counsel investing clients on the likely upcoming pace of available assets.  As a result, our dealership consistently outperforms in terms of percentage of paper we place in relationship to the total number of dealers for any given corporate issuer. More importantly, we take great care to attract new investors to programs and work diligently to diversify the buyers for our issuing clients – investor concentration has been one of the key reasons why some issuers have struggled during times of stress or increased issuance requirements. Finally, we have “housed” the commercial paper dealership in our primary syndicate desk, rather than in a trading business like most other banks, to further align it with our banking efforts and advise clients on their issuance options from the very short end (CP, FRN) to the multitude of options out the curve. In summary, we are a strong champion of the commercial paper markets and proud of the role our dealership has for both issuing and investing clients in this market.
This document is NOT a research report under the legal requirements in any country or jurisdiction designed to promote the independence of investment research and is NOT a product of a fixed income research department. This document has been prepared for institutional clients, sophisticated investors and market professionals only, on the basis of publicly available information. This communication has been produced by and for the primary benefit of a syndicate desk. It is not investment research nor considered impartial in relation to the activities of this syndicate desk. 

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