Commercial PaperWhat to Expect (all in 20 Minutes)What is Commercial Paper?A Brief History LessonThe Contemporary Commercial Paper MarketContemporary Market – Recent GrowthIssuersIntermediariesBuyers and ConsumersCreditworthinessCredit RatingsRecent InnovationsForeign MarketsConcluding RemarksQuestions?Commercial PaperJim KellyBA543-002May 12, 2005What 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 QuestionsWhat 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 < 90 Days; Collateral for the Federal ReserveA 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 1997The 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 RateContemporary 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 OutstandingsIssuers•Finance Companies–GMAC–GE Capital–Ford Motor Credit–Merrill Lynch–JP Morgan–PepsiCo•Short-Term Needs and a Very High Credit RatingIntermediaries•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 ForcesBuyers 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 CorporationsCreditworthiness•Credit Ratings Issued by A Credit Agency–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 FirmsCredit Ratings•Strong Correlation Between Commercial Paper Debt Ratings and Term Debt Ratings•Somewhat Archaic System (Credit Cliff)Term Rating Term Ratings OutstandingsCP Rating CP Ratings OustandingsAAA to A 68% Tier-1 88%A- to BBB 20% Tier-2 7%BBB- and lower10% Tier-3 and lower4%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 Off-Balance Sheet Activities•Highly Rated Asset-Backed Paper is an Easy Sell•“Independence Day” Financed Through CP Tied to Film ReceivablesForeign 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•FranceConcluding 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
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