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Thu, Aug 23, 2007 - Page 10 News List

Commercial paper becoming harder to sell


Commercial paper, usually a quick and easy way for companies to get cash, has become harder to sell amid the shrinking of the worldwide credit market.

Several companies -- KKR Financial Holding LLC, hedge fund Sentinel Management Group Inc, Toronto investment bank Coventree Inc and US home lender Thornburg Mortgage Inc -- suggested last week, before the US Federal Reserve cut its discount rate cut to help settle the markets, that they were having problems accessing cash in the commercial paper market.

And even after the Fed acted on Friday, London mortgage lender HBOS PLC said its credit-investment vehicle will repay maturing asset-backed commercial paper from the bank's balance sheet, instead of using the credit markets. That announcement on Tuesday came a day after the National Bank of Canada said it agreed to buy nearly US$1.9 billion in asset-backed commercial paper held by the company's mutual funds and investors to eliminate its customers' exposure to that market, where it said "conditions have become extremely abnormal."

Commercial paper refers broadly to the bonds companies sell to borrow money for a short time -- on average, 30 days. About half of commercial paper is backed by collateral such as mortgage portfolios, stocks or credit card debt.

Commercial paper has long been a popular means for companies to get short-term cash, because it has looser terms and lower interest rates than bank loans. Also, selling the debt is usually fast and cheap because it does not need to be registered with the US Securities and Exchange Commission.

But investors appear to be shying away from debt with any risk attached to it. If one examines the rates on these bonds, it certainly looks like things have gone awry.

The discount rate on asset-backed commercial paper has spiked over the past week from about 5 percent to about 6 percent, according to US Federal Reserve data. This indicates weak demand -- when bond prices fall, rates rise.

"It's a demand issue more than anything. There's a reluctance to buy commercial paper," said Cowen & Co trading analyst Mike Malone.

He said there's primarily trouble in selling mortgage-backed commercial paper, especially those backed by mortgages that aren't provided by government lenders Fannie Mae or Freddie Mac.

"The fundamental issue is whether the investor or buyer of asset-backed commercial paper has confidence in the performance of the underlying collateral, as well as the ability to evaluate that expected performance given current market conditions and get appropriately paid for that risk," said Scott Baret, a partner in Deloitte & Touche LLP's capital markets practice, in an e-mail.

John Lonski, chief economist of Moody's Investor Service, pointed to the "glaring discrepancy" between the rate paid on prime asset-backed commercial paper and the rate paid on prime non-securitized commercial paper.

On Monday, the seven-day prime asset-backed commercial paper rate was 6.03 percent, well above the 7-day prime non-asset-backed commercial paper rate of 5.23 percent. In June, these two 7-day rates were both at around 5.3 percent.

The Fed's discount rate, meanwhile, is 5.75 percent.

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