Corporate America adopts IOUs at the end of free money

Blue chip companies that need to borrow in the United States are now increasingly relying on commercial paper to avoid locking in longer-term borrowing costs in a turbulent market.
The total amount of such outstanding IOUs has soared to nearly $1.2 billion this year, up more than 20% from its 2020 lows, IT giant Apple Inc and owner of the Kinder Morgan Inc. pipeline among those who tapped the market more this year. year. At the same time, investment-grade companies are relying less on longer-term debt markets, with sales of investment-grade corporate bonds falling around 7% in 2022, according to data compiled by Bloomberg.
If you exclude banks and other financial companies, sales of this type of debt in the first half of this year were the weakest since at least 2016, according to BMO Capital Markets. Companies are essentially betting that the Fed will get inflation under control and that longer-term rates will stabilize after rising for much of the year.
“All of this volatility is causing companies to try and ride it out with issuing commercial paper as a placeholder for them until things start to calm down,” said Peter Yi, director of fixed income at term and head of credit research at Northern Trust. Asset Management, which oversees approximately $1.2 billion.
By reclaiming commercial paper, companies are returning to a market that is used to stalling during systemic crises. But lately, borrowing in the longer-term markets has become trickier than usual.
There were around 49 days in 2022 when no companies sold corporate bonds, which may imply the market was essentially closed, compared to 12 days in the same period last year, according to compiled data. by Bloomberg News. An index of bond market volatility, the ICE BofA MOVE Index, had climbed to 128.27 on Monday from 77.1 at the end of last year.
The Fed is in tightening mode – officials are widely expected to raise the central bank’s benchmark by 0.75 percentage points in its next decision on Wednesday, so rates on the shorter parts of the curve loans are not expected to recede anytime soon. The longer-term outlook is harder to predict, especially if rate hikes end up pushing the economy into a slump.
There are already early signs of a potential recession, including an inversion of key segments of the Treasury yield curve and news this week from big-box retailer Walmart Inc that shoppers are cutting spending. This kind of macroeconomic uncertainty made many investors reluctant to buy longer-dated corporate bonds from companies that were willing to venture into the market.
Meanwhile, increased investor demand for commercial paper has made financing relatively cheap for companies in this market. For example, borrowing for 30 days in the commercial paper market may cost around 2.25% as of Monday, while yields on investment-grade bonds maturing in one to three years averaged around 3. .95%. The spread between these two rates – a measure of CP’s market borrowing savings – is significant compared to the averages of the past five years.
“I think supply has followed demand here, and that reflects the big gap in commercial paper rate pricing relative to the initial bond market,” said JPMorgan Chase & Co. strategist Nathaniel Rosenbaum.
Banks have been major sellers of commercial paper for years, but the biggest shift recently has been among firms outside the financial sector, said Erin Gonzalez, head of commercial paper trading at Barclays Plc. The stock of commercial paper bottomed out at around $945 billion in September 2020 before bouncing back, according to Fed data. The total amount outstanding is $1.17 billion as of July 20, although it is still only about half of its 2007 peak.
“We see businesses coming back,” Gonzalez said. “Private issuers who pulled out during the crisis are coming back.”
Even as companies increasingly borrow from the commercial paper market, some fund managers remain cautious. During the turmoil of March 2020, panicked investors withdrew billions of monetary funds within weeks, contributing to the seizure of the commercial paper market. Companies had to repay their IOUs coming due with precious money or money from a bank line.
This forced the Federal Reserve to provide emergency support to ensure markets, and even money market funds, would continue to function. The Fed had to similarly support the commercial paper market after the collapse of Lehman Brothers.
“The experience we have witnessed over the past two decades with commercial paper – which not only saw massive revaluations but also prompted formal responses from the Fed – is still relatively fresh in our minds. said Jerome Schneider, head of short-term portfolio management and financing at Pacific Investment Management Co, one of the world’s largest fixed income fund managers.
Regulatory changes in the U.S. money market industry have undermined demand for commercial paper for years, and more changes are coming that could further reduce fund purchases. Blue-chip money market funds buy about $480 billion in short-term IOUs each year, up from $725 billion in 2019, John Kodweis, head of commercial paper issuance at JPMorgan, said at a conference. a conference last month.
Despite all the worries about past turmoil and potential regulatory changes, short-term investors have ample amounts of cash and are looking for places to invest it. And many companies take comfort in knowing that the Fed is inclined to keep the market going if it crashes, Barclays’ Gonzalez said.
“Emitters who had been gone for a while would likely have felt comfortable returning by the end of 2020,” she said. “Going forward, they’re not as worried knowing the Fed stepped in and did what they did.”
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