Federal Reserve Chairman Ben S. Bernanke's decision to deny commercial paper financing to all but the highest-rated borrowers is forcing some companies to seek the credit of last resort, backstop loans.
Whirlpool Corp., American Electric Power Co. and AGL Resources Inc. chose to tap emergency bank lines negotiated before the credit crisis began rather than pay twice as much on commercial paper. The defections helped shrink sales of the IOUs in the past two weeks to the lowest in more than two years.
``You've got all these people taking loans that don't want loans. They want CP,'' said Christopher Low, New York-based chief economist at FTN Financial, a unit of Tennessee's largest bank. ``All of these programs have had unintended consequences elsewhere. Every time the government elevates one class of debt it displaces another.''
The $1.6 trillion market for commercial paper, which is used to finance everything from payroll to power, was one of the few funding options still available as the corporate bond market froze and yields soared to the highest in almost two decades.
Federal Reserve buying of 90-day commercial paper began Oct. 27 as part of an effort to unlock the market, which seized up in September after Lehman Brothers Holdings Inc. filed for bankruptcy. Purchases were restricted only to debt rated A-1 or A-1+ by Standard & Poor's, P-1 by Moody's Investors Service or F1 or F1+ by Fitch Ratings.
Three Alternatives
The limit gave investment-grade companies in the second tier of ratings, with about $80 billion of the debt, few alternatives. They could continue to pay record rates relative to benchmarks, sell bonds at the highest yields since 1990 or turn to their emergency credit facilities.
Lower-rated corporations taking out loans may add costs for banks already reeling from almost $1 trillion of writedowns and loan losses since the credit crisis began in 2007.
When bank lines are tapped, the obligation moves onto balance sheets, requiring financial firms to set aside even more capital to offset the liability. Lenders will be reluctant to refinance current revolvers at similar rates when they come due in two or three years.
Hotel Loan
Marriott International Inc., the biggest U.S. hotel chain, borrowed $900 million on a revolving loan to repay commercial paper, the first time the Bethesda, Maryland-based company has drawn it down since September 2001.
The credit line costs 0.35 percentage point over the three- month London interbank offered rate, or 2.48 percent, about half the market average on seven-day CP of 4.84 percent. Libor is the rate at which banks in London are willing to lend money to each other.
``I just feel a little bit better having the cash in my pocket,'' Laura Paugh, senior vice president of investor relations at Marriott told analysts during an Oct. 15 conference call. ``I don't have to worry about rolling over the commercial paper.''
American Electric, the biggest U.S. producer of electricity from coal, borrowed about $600 million in September and $1.4 billion in October under two revolving credit facilities to pay off $400 million of commercial paper and ensure it has cash to repay debt coming due, Chief Financial Officer Holly Koeppel said. The company is rated A-2/P-2.
The revolving debt, which matures in 2011 and 2012, costs about 3 percent to 4 percent, compared with about 6 percent for 30-day paper. ``It's cheaper than any other money out there,'' Koeppel said.
`First Step'
Rates will probably come down for second-tier borrowers as the central bank increases lending and money-market funds worry less about redemptions with the start of another Fed program later this month. That will free them to take more risk, Low said.
``The first step is comfort level with the higher-rated issuers,'' said Diane Vazza, head of global fixed income at Standard & Poor's in New York. ``To the extent that investors start to feel comfortable, they'll tiptoe back in to pick up some incremental yield on that next tier of rated companies. But that's going to take time.''
At least $80.6 billion of the market is considered ``tier- two'' because it's rated A-2, P-2 or F2, according to Fed data. About $1.3 trillion is tier one and the rest is either rated lower or doesn't fit either category for another reason.
Genworth Plunge
Genworth Financial Inc., the Richmond, Virginia-based insurer spun off by General Electric Co., lost more than half its value after Moody's Investors Service cut the short-term debt rating one step to P-2 on Nov. 10, leaving the company ineligible for Fed commercial-paper purchases, according to a regulatory filing.
Money-market funds, the biggest buyers of commercial paper, are still reluctant to lend for more than a few days to tier-two companies, forcing issuers to come to the market almost daily and pay some of the highest spreads on record. Money-market funds facing record redemptions are holding onto U.S. Treasury bills and restricting commercial paper lending to the safest borrowers.
``It doesn't matter how wide the spread gets, I'm not going to be buying,'' said David Glocke, head of taxable money markets at Vanguard Group Inc. in Valley Forge, Pennsylvania, who manages $140 billion in assets.
The Fed is unable to buy tier-two companies' commercial paper because the ``law requires we be adequately secured,'' Bernanke said during an Oct. 20 House Budget Committee hearing.
Tier-two borrowers issued $21.5 billion of commercial paper last week, following 20.6 billion the week before, the slowest full week since February 2006 and half the total three months ago, Fed data show.
Paying a Penalty
Since Oct. 7, when the Fed announced the program, offer rates on tier-two 30-day paper increased 0.12 percentage point to 5.64 percent on Nov. 10, or a record 4.1 percentage points more than one-month Libor, according to data compiled by Bloomberg.
Yields for borrowers one step higher plunged 3.28 percentage points to 0.88 percent, or 0.66 percentage point less than Libor. That implies a penalty of 4.76 percentage points for the lower rating, compared with 0.5 percentage point in May and 0.07 two years ago.
AGL Resources Inc., the owner of Atlanta's natural gas utility, has repaid commercial paper by tapping a bank line with an interest rate of 28 basis points over one-month Libor, or about 1.69 percent. That compared with 5 percent to 6 percent for overnight commercial paper for the A-2 rated borrower, Chief Financial Officer Andrew Evans said.
Whirlpool, the world's largest appliance maker, borrowed $800 million from a credit line to pay off outstanding commercial paper, opting to exit the market because of ``uncertainty concerning access,'' according to an Oct. 31 filing. The company, rated A-2/P-2, said the revolver has a rate of 0.35 percentage point over Libor.
``If the market remains difficult for another couple of weeks, I think you will see an increasing number of companies turn to alternative financing,'' Low said.
Whirlpool Corp., American Electric Power Co. and AGL Resources Inc. chose to tap emergency bank lines negotiated before the credit crisis began rather than pay twice as much on commercial paper. The defections helped shrink sales of the IOUs in the past two weeks to the lowest in more than two years.
``You've got all these people taking loans that don't want loans. They want CP,'' said Christopher Low, New York-based chief economist at FTN Financial, a unit of Tennessee's largest bank. ``All of these programs have had unintended consequences elsewhere. Every time the government elevates one class of debt it displaces another.''
The $1.6 trillion market for commercial paper, which is used to finance everything from payroll to power, was one of the few funding options still available as the corporate bond market froze and yields soared to the highest in almost two decades.
Federal Reserve buying of 90-day commercial paper began Oct. 27 as part of an effort to unlock the market, which seized up in September after Lehman Brothers Holdings Inc. filed for bankruptcy. Purchases were restricted only to debt rated A-1 or A-1+ by Standard & Poor's, P-1 by Moody's Investors Service or F1 or F1+ by Fitch Ratings.
Three Alternatives
The limit gave investment-grade companies in the second tier of ratings, with about $80 billion of the debt, few alternatives. They could continue to pay record rates relative to benchmarks, sell bonds at the highest yields since 1990 or turn to their emergency credit facilities.
Lower-rated corporations taking out loans may add costs for banks already reeling from almost $1 trillion of writedowns and loan losses since the credit crisis began in 2007.
When bank lines are tapped, the obligation moves onto balance sheets, requiring financial firms to set aside even more capital to offset the liability. Lenders will be reluctant to refinance current revolvers at similar rates when they come due in two or three years.
Hotel Loan
Marriott International Inc., the biggest U.S. hotel chain, borrowed $900 million on a revolving loan to repay commercial paper, the first time the Bethesda, Maryland-based company has drawn it down since September 2001.
The credit line costs 0.35 percentage point over the three- month London interbank offered rate, or 2.48 percent, about half the market average on seven-day CP of 4.84 percent. Libor is the rate at which banks in London are willing to lend money to each other.
``I just feel a little bit better having the cash in my pocket,'' Laura Paugh, senior vice president of investor relations at Marriott told analysts during an Oct. 15 conference call. ``I don't have to worry about rolling over the commercial paper.''
American Electric, the biggest U.S. producer of electricity from coal, borrowed about $600 million in September and $1.4 billion in October under two revolving credit facilities to pay off $400 million of commercial paper and ensure it has cash to repay debt coming due, Chief Financial Officer Holly Koeppel said. The company is rated A-2/P-2.
The revolving debt, which matures in 2011 and 2012, costs about 3 percent to 4 percent, compared with about 6 percent for 30-day paper. ``It's cheaper than any other money out there,'' Koeppel said.
`First Step'
Rates will probably come down for second-tier borrowers as the central bank increases lending and money-market funds worry less about redemptions with the start of another Fed program later this month. That will free them to take more risk, Low said.
``The first step is comfort level with the higher-rated issuers,'' said Diane Vazza, head of global fixed income at Standard & Poor's in New York. ``To the extent that investors start to feel comfortable, they'll tiptoe back in to pick up some incremental yield on that next tier of rated companies. But that's going to take time.''
At least $80.6 billion of the market is considered ``tier- two'' because it's rated A-2, P-2 or F2, according to Fed data. About $1.3 trillion is tier one and the rest is either rated lower or doesn't fit either category for another reason.
Genworth Plunge
Genworth Financial Inc., the Richmond, Virginia-based insurer spun off by General Electric Co., lost more than half its value after Moody's Investors Service cut the short-term debt rating one step to P-2 on Nov. 10, leaving the company ineligible for Fed commercial-paper purchases, according to a regulatory filing.
Money-market funds, the biggest buyers of commercial paper, are still reluctant to lend for more than a few days to tier-two companies, forcing issuers to come to the market almost daily and pay some of the highest spreads on record. Money-market funds facing record redemptions are holding onto U.S. Treasury bills and restricting commercial paper lending to the safest borrowers.
``It doesn't matter how wide the spread gets, I'm not going to be buying,'' said David Glocke, head of taxable money markets at Vanguard Group Inc. in Valley Forge, Pennsylvania, who manages $140 billion in assets.
The Fed is unable to buy tier-two companies' commercial paper because the ``law requires we be adequately secured,'' Bernanke said during an Oct. 20 House Budget Committee hearing.
Tier-two borrowers issued $21.5 billion of commercial paper last week, following 20.6 billion the week before, the slowest full week since February 2006 and half the total three months ago, Fed data show.
Paying a Penalty
Since Oct. 7, when the Fed announced the program, offer rates on tier-two 30-day paper increased 0.12 percentage point to 5.64 percent on Nov. 10, or a record 4.1 percentage points more than one-month Libor, according to data compiled by Bloomberg.
Yields for borrowers one step higher plunged 3.28 percentage points to 0.88 percent, or 0.66 percentage point less than Libor. That implies a penalty of 4.76 percentage points for the lower rating, compared with 0.5 percentage point in May and 0.07 two years ago.
AGL Resources Inc., the owner of Atlanta's natural gas utility, has repaid commercial paper by tapping a bank line with an interest rate of 28 basis points over one-month Libor, or about 1.69 percent. That compared with 5 percent to 6 percent for overnight commercial paper for the A-2 rated borrower, Chief Financial Officer Andrew Evans said.
Whirlpool, the world's largest appliance maker, borrowed $800 million from a credit line to pay off outstanding commercial paper, opting to exit the market because of ``uncertainty concerning access,'' according to an Oct. 31 filing. The company, rated A-2/P-2, said the revolver has a rate of 0.35 percentage point over Libor.
``If the market remains difficult for another couple of weeks, I think you will see an increasing number of companies turn to alternative financing,'' Low said.
