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31304_1975-1979

31304_1975-1979

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The Commercial Paper Market
This article was prepared by Evelyn M. Hurley
 
 of the Capital Markets Section of the Boards
 
 Division of Research and Statistics. All notes
 
 and/or references cited appear at the end of the
 
 article.
Over the past decade, an increasing number of 
 
large corporations have met part of their credit
 
needs through the sale of commercial paper—
 
unsecured short-term promissory notes that are
 
offered to investors either through dealers or
 
directly by the issuer.1Most commercial paper
 
carries an initial maturity of 60 days or less,
 
and only financially strong, highly rated borrowers have access to this market. To insure
 
payment at maturity, issuers generally maintain
 
back-up lines of credit at banks. The predominant investors in commercial paper are large
 
institutions—such as insurance companies,
 
nonfinancial corporations, and bank trust
 
departments—which use these obligations as a
 
relatively low-risk outlet for short-term funds.The volume of commercial paper outstanding
 
has increased fivefold during the past 10 years.
 
At the end of 1976 about 700 firms had $52.6
 
billion, seasonally adjusted, of such paper outstanding (Table 1). More than 60 per cent of 
 
that total had been placed directly with investors—mostly by large finance and bank holding
 
companies that have continuing, substantial
 
needs for short-term credit. The remainder, all
 
of which had been offered through dealers,
 
represented issues primarily of nonfinancial
 
corporations and of smaller finance and bank
 
holding companies. These issuers typically have
 
irregular and relatively smaller financing requirements.For the firms that issue it, commercial paper
 
is an important substitute for bank credit. Such
 
substitution is especially prevalent among those
 
offering paper through dealers. These issuers do
 
not maintain a special staff to market theirpaper, and they have less incentive to stay in
 
the market on a continuous basis to maintain
 
investor contacts and acceptance. As a result,
 
growth in dealer placed paper often accelerates
 
or decelerates in response to changes in the
 
relative cost and availability of bank credit.For the many investors that buy it, commercial paper—because of its relatively low risk and
 
short maturity—is a close substitute for money
 
market instruments such as Treasury bills
 
and large-denomination certificates of deposit
 
(CD’s). As a consequence, yields on commercial paper move in concert with yields on these
 
other short-term market instruments. Due to the
 
lack of a well-developed secondary market,
 
however, commercial paper ordinarily requires
 
a small premium above rates on other, more
 
liquid short-term instruments.The following discussion presents a more
 
detailed examination of commercial paper issuers and of the distribution mechanism. The
 
review includes a description of ratings and the
 
rating agencies, together with further information on investors in commercial paper. There1. Commercial paper outstanding
Seasonally adjusted, in billions of dollarsTypeJan. 31, 1966Dec. 31, 1976Total .........................................10.152.6Financial firms ....................10.039.7Dealer placed
................
1.77.3Bank-related
..............
1.9Other ...........................1.75.4Directly placed
..............
8.332.4Bank-related
..............
6.0Other ...........................8.326.4 Nonfinancial firms ..............113.0 Note.—Monthly data for total commercial paper and its major components for the period 1966-76 will be published in the Board’s forthcoming
 Annual Statistical Digest,
 
1972-1976.
Components may not add to totals due to rounding.
 
June 1977
 
526 Federal Reserve Bulletin June 1977
is also an exploration of yield structure, redemption procedures, and practices regarding
 
maturities and back-up lines of credit. The discussion concludes with a short .analysis of the
 
growth of the market, particularly since World
 
War II.
ISSUERS OFDIRECTLY PLACED PAPER 
Of the total volume of commercial paper outstanding at the end of 1976, $32.4 billion, or
 
more than 60 per cent, had been placed directly
 
by the borrowing firm with the investor without
 
the use of a dealer as intermediary (Table 2).
 
Currently, only about 75 companies offer their
 
paper in this way. For the most part, these are
 
very large finance companies and bank holding
 
companies that have top credit ratings, extensive
 
banking and money market relationships, and
 
a continuous need for large amounts of shortterm funds.A considerable amount of borrowing is required to justify the substantial fixed costs of 
 
distributing paper without dealer assistance. As
 
a result, issuers seldom find it economical to
 
place paper directly unless the average monthly
 
volume of their paper outstanding exceeds $100
 
million; in fact, average amounts outstanding
 
of such paper at the end of 1976 were around
 
$650 million per issuer. Purchases of new issues
 
of directly placed paper also are large, usually
 
about $500,000 per investor. Furthermore, in
 
the case of one or two issuers that sell to large
 
institutions, sales of new paper average as much
 
as $1 million per investor.By distributing commercial paper on their
 
own, issuers save the dealer’s fee of
Vs
 of a
 
percentage point, or $125,000 per $100 million
 
of paper offered. Direct placement also allows
 
greater flexibility in adjusting interest rates and
 
maturities to meet an investor’s preferences.Offsetting these advantages to some extent is
 
the need to set up and maintain a marketing
 
department. Another offsetting factor is that
 
direct issuers typically accommodate customers
 
by accepting all orders at quoted interest rates,
 
even if the issuer’s need for funds is already
 
satisfied.2 As a result, there are times when
 
excess funds may have to be reinvested in2. Directly placed commercial paper
 
outstanding, by type
End-of-year figures, seasonally adjusted; in billions of dollarsYear Total Nonbank Bank-related 1966
.......................
11.111.11967
.......................
12.712.71968
.......................
14.614.61969
.......................
20.817.73.11970
.......................
20.518.52.01971
.......................
20.619.21.41972
.......................
22.120.71.41973
.......................
27.224.32.91974
.......................
31.825.36.51975
.......................
31.224.36.91976
.......................
32.426.46.0
money market instruments, perhaps on unfavorable terms.Other costs, incurred by both direct placers
 
and those distributing paper through dealers,
 
include: (1) reimbursement of banks for back-up
 
lines of credit—usually with compensating balances of 10 per cent of total lines extended to
 
the issuer, plus an additional 10 per cent of lines
 
actually used; (2) fees to a money market bank
 
that acts as the issuer’s agent in the collection
 
and payment of notes; and (3) fees to rating
 
services for evaluating commercial paper.Finance companies are the major issuers of 
 
directly placed paper, accounting for more than
 
80 per cent of the total of such paper outstanding
 
at the end of 1976. These issues have been an
 
important and growing source of funds for finance companies. By mid-1975—the latest period for which data are available—directly
 
placed paper represented 65 per cent of the total
 
short-term debt of these companies, up from
 
nearly 50 per cent 10 years earlier.3 By comparison, over the same period, the bank loan
 
portion of short-term obligations of finance
 
companies fell from 36 to 22 per cent.It must be noted, however, that only a small
 
nilmber of very large finance companies have
 
access to the directly placed commercial paper
 
market. According to the 1975 Federal Reserve
 
survey of finance companies—which covered
 
nearly 3,400 firms—46 companies, each reporting combined business and consumer accounts
 
receivable of $100 million or more, accounted
 
June 1977
 
Com m ercial Paper Market
 5 27
for 99 per cent of all commercial paper placed
 
directly by finance companies and outstanding
 
at the time of the survey.About one-fifth of all finance company commercial paper outstanding is issued via ‘ ‘master
 
notes,” which are sold to large, steady suppliers
 
of funds such as bank trust departments. Under
 
these master note agreements, bank trust
 
departments make daily purchases of commercial paper, payable on demand, up to some
 
predetermined amount. Each day the trust
 
department informs the issuer of the amount of 
 
paper it will take under the master note. Though
 
the amount outstanding may fluctuate from day
 
today, interest is usually payable on the average
 
daily balance for the month, at the 180-day
 
commercial paper rate.Bank holding companies represent the second
 
largest group of issuers of directly placed commercial paper. These firms did not begin to tap
 
this market until 1969, but by the end of 1976
 
they accounted for about 18 per cent of all
 
such paper outstanding. Although the paper
 
itself is an obligation of the bank holding company or its nonbank affiliates or subsidiaries, the
 
proceeds from such sales may be channeled to
 
the subsidiary bank or to other affiliates and
 
subsidiaries. If the proceeds are channeled to
 
a Federal Reserve member bank, they are sub ject to reserve requirements.
ISSUERS OF DEALER PLACED PAPER 
More than $20 billion of the commercial paper
 
outstanding at the end of 1976, or about 38 per
 
cent of the total, had been sold through dealers
 
(Table 3). Borrowers market their paper through
 
dealers for several reasons: they may not be well
 
enough known to issue paper without dealer
 
contacts; their needs may be temporary; or their
 
financing requirements may be too small to
 
 justify an in-house marketing department. More
 
than 650 corporations currently sell or guarantee
 
paper in the dealer market.4 Of these, about 300
 
are industrial companies and 170 are public
 
utilities (Table 4). Smaller finance companies
 
and bank holding companies, as well as mortgage companies and firms engaged in trans-3. Dealer placed commercial paper
 
outstanding, by type
End-of-year figures, seasonally adjusted; in billions of dollarsYear Total NonfiFinancialnancialTotal Non- banBank-related 1966
................
3.2.82.42.41967
................
5.22.32.82.81968
................
7.53.04.54.51969
................
12.25.76.55.31.21970
................
13.07.65.55.1.41971
................
11.96.65.34.8.51972
................
13.07.45.64.41.21973
................
14.38.85.53.51.91974
................
17.913.34.62.81.81975
................
16.910.76.24.51.81976
................
20.313.07.35.41.9
 N
o t e
 .—C
omponents may not add to totals due to rounding.
portation, insurance, and leasing, plus a few real
 
estate investment trusts (REIT’s), account for
 
the remainder.In view of the prevalence of industrial companies and the utilities among issuers, it is not
 
surprising to find that nonfinancial corporations
 
account for more than 60 per cent of the outstanding paper issued through dealers. These
 
corporations typically use paper to meet seasonal needs, or as a substitute for bank credit
 
because of relative cost, or at times to delay
 
longer-term financing because of unfavorable
 
market conditions. Although most of these firms
 
have a net worth of $100 million or more, a
 
few have a net worth as low as $50 million.
 
The smaller companies, however, are not heavily leveraged, and they have very good financial
 
records or the guarantee of a well-established
 
parent company. Many oil pipeline companies,
 
for example, are able to sell paper backed by
 
their parent oil companies, although they have
 
considerably lower net worth than other issuers.At the end of 1976 about 160 financial firms
 
were using the dealer market, and their paper
 
outstanding amounted to $7.3 billion (Table 3),
 
of which one-fourth was bank related. These
 
firms, which include smaller and less well-
 
known bank holding companies and finance
 
companies (primarily finance subsidiaries of 
 
manufacturers and retailers), usually have a net
 
June 1977

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