Critical time for Fed's CP facility

By Paul J Davies and Michael Mackenzie Published: January 30 2009 02:00 Last updated: January 30 2009 02:00 The next couple of weeks will prove an important test of the health of short-term lending markets in the US and whether companies still need the helping hand of the Federal Reserve to get money through the door. In the three months since the Fed opened up its commercial paper funding facility (CPFF) on October 27, the volume of 90-day borrowing companies have drawn from it has steadily risen, reaching about $351bn by Wednesday January 21, the most recent date for which data is available. The programme and its companion money market investor funding facility (MMIFF) were designed to help companies and financial institutions issue short term debt after US money market funds were hit with a wave of redemptions in the panic following the collapse of Lehman Brothers. The next fortnight will be critical because a huge volume of corporate paper issued into the CPFF in its first days comes due for refinancing. According to analysts at Morgan Stanley, $145bn of paper has been maturing throughout this week and another $98bn will mature next week. The latest Fed data on commercial paper market activity released yesterday showed a net reduction of almost $100bn in CP outstanding by the end of Wednesday across the markets, with the majority of this coming from a contraction in CP from financial institutions. Meanwhile, US non-financial corporates added just a net $3.8bn in CP this week, although because the data only shows activity up until Wednesday, it does not cover 90-day paper that was issued in the last three days of October when the CPFF was up and running. Interested observers will not be able to tell how much of that stayed with the Fed and how much corporates managed to push into the private markets until the central bank releases another balance sheet statement next Thursday. These statements are published a week in arrears. "Anyway you look at it, this will be one of the first true tests of a Fed liquidity programme post fourth-quarter stresses as CPFF might be in the midst of being unwound or at least used less frequently," says George Goncalves, strategist at Morgan Stanley. The big hope among regulators is that the use of the CPFF will shrink, as this would indicate the private sector is functioning once more. There has already been an increase in the proportion of CP issued that has maturities of 81 days and over, versus other maturities. This along with the latest Fed data indicates that companies could be looking to refinance what was put into the CPFF at the same maturity. According to Morgan Stanley analysts, about 25 per cent of paper issued last week was 81 days-plus paper, a very high proportion historically, matched in recent times only by the period around the opening of the CPFF (see chart). However, rates have increased too, according to the Fed data, especially for unsecured financial paper at the longer maturities, where rates jumped back above 200 basis points, from less than 100bp. This rise has come at a time when outstanding volumes of financial CP have dropped by $118bn over the month, which analysts said was partly due to the passing of the year-end period when funding needs were greatest, but also reflected a move towards issuing longer term debt into the bond markets in January. Financial CP has its own Fed facility in the form of the MMIFF, but use of this has remained at zero since it was launched, which is one reason why rates on financial CP remain higher than those on non-financial. Part of the reason is that banks and other financial institutions have been able to issue long-term debt that is backed by the Federal Deposit Insurance Corp. Last year, the FDIC launched the Temporary Liquidity Guarantee Program, which backs debt for up to three years. But the sharp rise in financial CP rates at a time when volumes are falling suggests renewed strains or risk aversion among money market investors - and so could bode ill for private participation in new non-financial corporate paper also. "If little returns to the CPFF in the next few days, it would demonstrate a dramatic improvement in the ability of the CP market to operate without Fed support," says another analyst. "We are not getting our hopes up, though," he added because there remains a very wide spread between rates on AA-rated CP that qualifies for the Fed scheme and A2-rated paper, which does not. "[This] suggests to us that Fed participation is still essential to reasonable pricing in this market." However, non-financial corporate CP rates for -AA-rated paper are quite healthy at about 49bp, according to the Fed data, which some said could be seen as a reason to expect less participation in the CPFF, which involves other expenses in terms of fees. Also, the interbank money market rates that shot higher in the wake of Lehman's collapse have fallen sharply since the CPFF was introduced in October. "With short-term funding spreads considerably improved, issuers will likely shy away from further CPFF participation at its current pricing scheme, which has not changed since the end of October," says Mr Goncalves.