US commercial paper outstanding stable: S&P

Our Economy Bureau
30 May 2002

Even though residual anxiety about headline risk has not completely evaporated and the ratio of US non-financial commercial-paper downgrades to upgrades remains uncomfortably high at 16.3 to 1, demand for commercial paper issuance is projected to rebound albeit gradually from the depths it plummeted to during the course of the past 18 months.

Indeed, market conditions for commercial paper appear to be easier, with spreads between tier-1 and tier-2 falling to 33 basis points as of 21 May 2002, compared with 70 basis point at yearend 2001. Such developments are consistent with US economic fundamentals and the timing of the current business cycle, says S&P head (Global Fixed Income Research) Diane Vazza.

With the economy on an upturn, the inventory run-off rate has slowed; and capacity utilisation rates are beginning to edge up even though they still remain well below the levels seen during the boom years of the mid-1990s. As business investment picks up steam, working capital requirements will accelerate among firms, in turn fuelling increased demand for commercial paper, Vazza adds.

The report points out that the changing monetary environment is expected to realign the balance between short-term securities (ex: commercial paper) and longer-term securities. During the previous accommodative cycle, a sustained period of record low interest rates and a flat yield curve incentivised companies to refinance and lengthen maturity of shorter-term debt.

Going forward, under the current restrictive phase, there will be renewed focus on issuance at the shorter end of the yield curve and reduced emphasis on terming out of commercial paper. As the economic recovery gets firmly under way, a more substantial pickup in corporate cash flows should eventually lead to fewer rating downgrades as well.

But the projected upturn in commercial paper will not match the torrid pace established in the late 1990s, when the availability of cheap money led to a precarious situation where many longer-term assets, including capital expenditures and mergers and acquisitions, were being funded in the short-term market, says Vazza.

The silver lining is that firms are emerging from the economic downturn with stronger balance sheets as a result of a more appropriate asset/liability mix, with commercial paper funding working capital requirements, such as inventory. Companies are, therefore, unlikely to seek out short-term financings that will be haunted by the looming spectre of rollover risk, particularly in a jittery market that is the object of intense scrutiny.