Sinking Commercial Paper Market

Sinking Commercial Paper Market
Broadens Effects of Enron Troubles

By GREGORY ZUCKERMAN
Staff Reporter of THE WALL STREET JOURNAL

For years, the commercial-paper market has served as the corporate world's automated teller machine, spitting out a seemingly endless supply of cash for businesses at super-low interest rates.

But now, amid financial jitters caused by Enron Corp.'s collapse, that machine is sputtering, sending a surprising number of companies of all sizes scrambling to find money for their most basic needs, from paying salaries to buying office supplies. Some are paying higher interest rates so they can keep selling paper. But others, after getting the cold shoulder from commercial-paper investors, have turned to raising debt by other, costlier, means. These companies include Qwest Communications International Inc., Sprint Corp., Gap Inc. and Computer Associates International Inc.

Tyco's New Costs

Last month, amid investor concerns about accounting at Tyco International Ltd., the conglomerate had to draw on a backup line of credit from its banks to come up with cash it needed. The move to replace cheap commercial paper with the more expensive bank line will cost Tyco about $400 million in additional after-tax, annual borrowing expenses, slicing about five cents per share from first-quarter earnings, which were expected to come in at 80 cents per share.

The commercial-paper "market has always been low-cost, ready capital -- it was always there for you," says Brad McGee, a Tyco executive vice president, who says the accounting concerns are overblown. "When a market like this dries up, it puts you in a position of greater risk."

For an economy still in the tentative stages of a turnaround, the problems in the commercial-paper market underscore the profound effect Enron's collapse has had on basic workings of American finance. Increasingly skittish about corporate-accounting practices, the ultra-conservative investors who control the commercial-paper market have cut back on a key source of liquidity. Economists worry that the troubles could help put a lid on capital spending, as companies scramble to save cash -- a move that could delay or even reverse the recovery.

"You're making a mistake if you forecast a big pickup in capital spending, because companies feel pressure to repair their balance sheets," says John Lonski, chief economist at Moody's Investors Service.

For the past 40 years, the massive commercial-paper market has been a critical -- and almost invisible -- lubricant for the economy. Through the commercial-paper market, companies issue IOU's for critical short-term financing, lasting for as long as 270 days or as short as one day. The money is used to pay for their most basic, immediate needs, though in recent years it has also covered billion-dollar acquisitions. Commercial paper generally doesn't require any collateral. It is the cheapest source of debt financing, with rates that typically are several percentage points below those of longer-term bonds and loans from banks. That's because it's less risky to lend money for a short period -- there's less chance for an unforeseen downturn in business.

The flexibility has always been a major plus. In good times a corporate treasurer can wake up one morning, call up a Wall Street investment bank and get it to sell commercial paper to investors to raise the exact amount the company needs. When the debt turns over, they do it again. Some large companies can even sell the debt directly to commercial-paper investors, which include money-market mutual funds, insurance companies and firms needing to park some extra cash.

Like running water, it's only missed when it stops flowing. The market first began experiencing difficulties about a year ago, as the economy slowed. Enron's collapse fueled more worry -- in part because it caused credit-rating agencies to become more hawkish. Stung by criticism that both Moody's and Standard & Poor's kept Enron at investment grade until just five days before it filed for bankruptcy last fall, the rating agencies started poring over balance sheets, looking for companies that seem overdependent on commercial paper.

In the fourth quarter of last year, Moody's downgraded 17 companies that had top commercial-paper ratings, up from five downgrades in the third quarter.

"Troubles can trigger an immediate downgrade from the agencies, when in the past that wouldn't have happened," says Greg Hahn, who runs bond investments for Conseco Capital Management. "I've never seen the market so nervous."

Since money-market funds and some other investors in the commercial-paper market have rules prohibiting them from putting more than 5% of their assets in lower-rated debt, such a ratings downgrade puts instant pressure on companies. Last week, Moody's released an extensive analysis of the reliance of 300 companies on short-term debt. Many interpreted this as a gentle nudge to reduce this reliance.

A New Attitude

Accounting issues have made investors such as Joseph Tully even more cautious than usual. Mr. Tully manages $60 billion at Prudential Investment Management in Newark, N.J., and is in charge of his firm's short-term investments, such as Prudential's money-market funds. Like others in this market, his job, above all else, is not to lose money. Beating his competitors is icing on the cake.

Since Enron, Mr. Tully is avoiding much of the second-tier sector of the commercial-paper market. Even when he believes in a company, lately he won't touch their debt if it's for longer than three months, he says. That's because he worries that the company's fortunes could change abruptly, meaning there's no guarantee it will be able to pay the money back.

"Twenty-five percent of the companies we used to look at aren't even open for discussion," he says. Mr. Tully says he and other investors in this market don't want to "be called in to meetings all day to explain why we own" debt of a troubled company.

This new attitude among commercial-paper investors, the church ladies of Wall Street, has led to a sharp reduction in commercial-paper issuance. Since December 2000, the overall value of commercial paper issued in the U.S. has shrunk 12%, to $1.4 trillion. That's a sharp reversal from previous annual growth rates of around 19%.

The cost is going up, too. Second-tier companies, which account for around $159 billion of borrowing, are paying annual rates of 2.24% to sell one-month debt, up from nearly 2% in late January. That's a relatively high spread compared with the 1.79% that top-rated companies are charged to borrow money for one month. Top-tier rates have also gone up some, from 1.6% in January.

The market is so bad that some lower-rated companies aren't even trying to sell new debt, realizing they wouldn't be able to find enough investors. Some foreign companies, such as ABB Ltd., Europe's biggest electrical-engineering company, also haven't been able to find enough investors to buy their short-term debt.

Other companies under pressure are finding they can find the money they need, but only by turning over every stone. Rates last month on one-week Qwest commercial paper spiked to unusually high levels, according to traders, as investors sold off their holdings, fretting over the telecom company's ability to meet its short-term expenses.

Like other companies lately, Qwest decided to tap backup bank lines of credit, though banks usually make these longer-term loans more expensive and restrictive than commercial-paper financing. Qwest also sold long-term bonds, with a hefty interest rate of almost 9%, and reiterated a pledge to sell assets and reduce its capital spending. Qwest says its finances are sound.

Sprint's Squeeze

Sprint, the long-distance and cellular provider, felt the squeeze last month. The company, which had been relying on the commercial-paper market for $3 billion of its day-to-day expenses, suddenly couldn't convince gun-shy commercial-paper investors to buy its debt. The cash crunch sent Sprint shares tumbling, and had credit-rating agencies sending warnings.

The result: Sprint was forced to take on more expensive debt, including a $1 billion new loan and $5 billion in long-term bonds, costing the company almost $200 million in additional borrowing costs each year, according to analysts. Like a homeowner cutting back on spending when his variable-rate mortgage shoots up, Sprint is now slashing its capital spending by $400 million.

Sprint CEO William Esrey says he was stunned by how fast the market shifted from an open spigot to nearly disappearing.

The commercial-paper "market has shrunk, people are saying they don't want to take a chance" on lending money to many companies with issues, says Mr. Esrey. "It's very frustrating because our performance hasn't changed."

The fears have gotten so bad that Pacific Investment Management Co., the $250 billion fund company known in the bond market for its aggressive bets, has slashed its holdings of lower-tier commercial paper to just 4% of its portfolio, down from 25% at the end of 1999.

"Surprises come out of nowhere these days," says Bill Gross, PIMCOs' chief investment officer, who reasons that the rewards of holding such debt is no longer enough to offset the new risks. "We're not shrinking violets, we'll just place our bets elsewhere."

Mr. Gross last week declared his firm wouldn't even buy commercial paper from General Electric Co., which has been relying on this market for about half its financing needs. The move sent shock waves throughout Wall Street, raising questions of whether even blue-chip companies would have to pay higher rates to raise money outside of the commercial-paper market, hurting profits.

Earlier this month, GE's GE Capital unit sold $11 billion of long-term bonds with higher rates than it was paying on its commercial paper. The move is part of a strategy to shift some of the company's debt out of the commercial-paper market.

CreditSights, an independent New York-based bond-analysis firm, estimates that the shift will cost GE over $100 million in additional annual interest payments. A GE spokesman says the extra cost won't be that high and won't materially affect earnings.

As recently as a few weeks ago, most top-tier U.S. companies shrugged off the commercial-paper problems. They were able to raise money at super-slim rates of about 2%, even while lower-rated companies such as Qwest and Computer Associates struggled to find takers for their debt. Many of those that have run into some problems in the market, such as Ford Motor Co.'s Ford Motor Credit and General Motors Corp.'s GMAC, have been able to "securitize" their commercial paper, turning their low-rated debt into higher-rated commercial paper by backing it with credit-card receivables or other assets. Companies with these assets have found ample investors: Such secured deals have grown to 52% of the entire commercial-paper market.

But now even first-tier companies are worried that the market just might not be there when they need it, even if they're having no trouble placing the debt right now. Verizon Communications Inc., a top-rated company that's having no problems selling $12.8 billion in commercial paper, nevertheless is preparing for the worst.

Verizon has sold $5 billion of longer-term debt in recent months, even though it had to pay higher rates that will cost the company about $100 million in additional annual interest. And the company is cutting capital spending to between $15 billion and $16 billion this year from $17.4 billion last year, in part to avoid having to turn to commercial-paper investors, says company spokesman Robert Verettoni.

"We saw this was going to be an issue months ago, so we've been acting ahead of time," says Mr. Verettoni, referring to the market's problems.

Other investment-grade companies, such as J.P. Morgan Chase & Co. and Household International Inc., have taken the unusual step of holding conference calls with investors to highlight their strong liquidity positions.

But for lower-tier companies, there's little good news to talk about. Tougher scrutiny by ratings agencies has produced a vicious cycle: Earlier this month, Standard & Poor's lowered its credit rating on Chicago-based GATX Corp., which leases rail cars and aircraft. The reason? The company's access to the commercial-paper market was curtailed, due to a downgrade by rival Moody's, which cited concerns about volatility in the aircraft-leasing business. Robert Lyons, the company's vice president of investor relations, said GATX has never been as dependent on the commercial-paper market as other companies, noting, "We have never viewed commercial paper as a quasi-permanent source of funding."

Write to Gregory Zuckerman at

Updated March 28, 2002