By Mike Antich
Today, Oct. 7, the Federal Reserve Board announced that it is invoking emergency powers to create a special fund to support the U.S. commercial paper market. According to Bloomberg, the Federal Reserve Board will purchase from eligible issuers three-month dollar-denominated commercial paper at a spread over the three-month overnight-indexed swap rate.
The current credit gridlock gripping much of the nation has made it more difficult (and expensive) to issue commercial paper. Companies such as AT&T, along with governmental entities such as the Commonwealth of Massachusetts and the State of California, reported difficulty selling commercial paper to help fund day-to-day expenses. Contributing to this hesitancy to buy commercial paper was the Sept. 15 bankruptcy of Lehman Brothers Holding, which had issued billions of dollars of commercial paper. This contraction in the issuance of commercial paper is broad-based and, as of press time, is now entering its fourth consecutive week. The market for commercial paper plummeted $94.9 billion to $1.6 trillion for the first week of October, as some banks and insurers were unable to find buyers for unsecured short-term debt.
Today's announcement by the Federal Reserve allows corporations to bypass this credit gridlock. This has an impact on the fleet market since one source of financing for large fleets is the commercial paper market.
Asset Backed Commercial Paper
Most fleet lessors fund themselves with asset backed commercial paper that matures between 90 and 180 days. The main form of asset backed commercial paper funding is conduit securitization. In these instances, asset backed commercial paper is sold through multiseller commercial paper (CP) conduits. A multiseller CP conduit is a special-purpose entity that regularly buys interests in pools of financial assets from one or more sellers and funds such purchases by selling commercial paper notes, primarily to institutional investors. Although the overall "appetite" for unsecured commercial paper has decreased, fleet companies selling asset backed commercial paper report that liquidity has not been an issue.
Traditionally, commercial paper is a less expensive alternative to bank-based borrowing, and all major fleet lessors offer a commercial paper-based rate to their large fleet customers. Commercial paper is a short-term promissory note issued by a company to raise short-term cash. The issuer of the note agrees to repay borrowed money within a range of one to 270 days, with 30 to 180 days being the most popular maturities.
Commercial paper as a funding instrument for fleet acquisitions emerged in the 1980s. Prior to this, companies funded fleet acquisitions using fixed-rate financing either individually negotiated or based on a benchmark, typically the Prime Rate. Also, the captive finance arms of auto manufacturers often lent money to lessors at a subsidized below Prime Rate.
Most large, creditworthy corporations saw the financial advantage to eliminate the "middleman fees" charged by commercial banks and issue their own commercial paper directly to lenders, typically institutional investors. In the past three decades, the commercial paper market literally skyrocketed. In 1975, there was $50 billion outstanding in commercial paper. By July 2007, the commercial paper market reached its zenith at $2.2 trillion.
Although a few fleet lessors issue unsecured commercial paper, the majority participate in the asset backed commercial paper market. Another source of fleet funding is securitization or term ABS (asset backed security), where the leases and collateral of only a single issuer are sold to the market.
Restoring Confidence in the Market
Today's action by the Federal Reserve Board is a bold (and unprecedented) measure to bust through the credit gridlock. Since much of the commercial paper issued matures on average within 30 to 45 days, this action will allow a large segment of this market to roll over with the assurance that there will be available funding.
In addition, it is crucial that the $700 billion federal bailout plan -- known as H.R. 1424 Emergency Economic Stabilization Act of 2008 -- succeed to restore broad-based confidence and credibility in the overall credit market. It is important that the provisions of H.R. 1424 be implemented quickly and decisively.
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