Commercial Paper

1
Commercial Paper

• Jim Kelly
• BA543-002
• May 12, 2005

2
What to Expect (all in 20 Minutes)

• 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

3
What is Commercial Paper?

• 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 lt 90 Days Collateral for the Federal
  Reserve

4
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

5
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

6
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

7
Issuers

• Finance Companies
• GMAC
• GE Capital
• Ford Motor Credit
• Merrill Lynch
• JP Morgan
• PepsiCo
• Short-Term Needs and a Very High Credit Rating

8
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

9
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

10
Creditworthiness

• Credit Ratings Issued by A Credit Agency
• Standard and Poors
• Moodys
• Duff and Phelps
• Fitch
• Almost All Issuers Maintain 100 Backing Through
  Bank Lines of Credit
• Credit Enhancements Are Leased from Higher-Rated
  Firms

11
Credit Ratings

• Strong Correlation Between Commercial Paper Debt
  Ratings and Term Debt Ratings
• Somewhat Archaic System (Credit Cliff)

12
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
  Off-Balance Sheet Activities
• Highly Rated Asset-Backed Paper is an Easy Sell
• Independence Day Financed Through CP Tied to
  Film Receivables

13
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

14
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

15
Questions?