Skip to content

The decline of commercial paper

Published on 21 Comments on The decline of commercial paper

Of all the things you don't care about, this might top the list:

In the corporate world, commercial paper is a small, short-term loan backed by nothing and used as working capital for things like financing payroll or receivables. In the financial world, money-center banks typically issue commercial paper as working capital to fund short-term loans. In either case it can be used only by companies so creditworthy they don't really need it, so why does anyone bother with it? I've never quite understood.

But maybe everyone is figuring that out, which is why commercial paper outstanding has been steadily on the decline for more than a decade. There's about a third less today than in 2015.

Does this matter? Does it mean anything? Or is it just one of those things? Does anyone know?

21 thoughts on “The decline of commercial paper”

  1. Anandakos

    I used to be an Accounts Payable clerk during the early 1980's when our line of credit [i.e. "commercial paper"] was 25.5% compounded daily. Obviously, we only used it under duress.

    But we DID use it when it allowed us to take a quick payment discount. In the wholesale foods business in those days, it was not uncommon to get terms of "2% 10 Net 30" from suppliers.

    They were nuts to offer that, so we took such a discount whenever we possibly could, even if it meant paying what was nearly 30% for a few days. That's because we got 2% back for committing working capital for twenty days. There are eighteen twenty-day periods in a year, so that means we could get 36% back and usually were able to pay off the loan within the current week.

    WE certainly didn't give our retail-outlet customers the same deal, and in fact during my two and a half years,the incidence of it being offered by our suppliers plunged. They "woke up" in the old meaning of the word.

    This is how commercial paper used to grease the wheels of commerce. The banks reserve the right to rein their paper customers in on the slightest whiff of difficulty, so there's almost no risk to them. The customers get access to working capital without having to share equity or encumber themselves with a fixed loan. It's a win-win. I expect that it is shrinking because small businesses use credit card "floats" instead now.

    1. Laertes

      "Oh hey, I didn't know about that, and that's an interesting question. I wonder if one of Kevin's readers is an expert on the subject who writes clear and concise explanations that are a joy to read." And here you are.

      2. Anandakos

        Thanks, guys. It's clear from what other folks have written below that my view of "commercial paper" is much too limited, but I'm glad that my experience of one form of it was interesting for you.

        Running a business during times of high inflation is tough. We, as a natural foods wholesaler, were kind of lucky because nearly everything we sold had a fairly short shelf-life anyway, so we didn't have to worry about the Incredible Shrinking Value of inventory purchased a couple of months ago. We specialized in produce, dried fruits and nuts, and dairy products, so we had to throw away most things that remained unsold after a couple of weeks anyway.

  2. Basilisc

    I suspect it has something to do with the supply of funds. Money market funds are the big buyers of CP. After the 2007-8 financial crisis regulations were tightened on money-market funds, requiring those who invested in private-sector paper ("Prime funds") to hold a certain amount of liquidity and restrict payouts in the case of investor outflows. This made these funds less attractive to investors, so they shrank, and bought less CP.

    Some useful background here: https://www.bis.org/publ/qtrpdf/r_qt2309e.htm

    1. KJK

      Explanation seems right to me. Also, after the Great Recession, issuers (and the rating agencies) realized that if there is financial distress (internal or external), the issuer may not be able to roll over its maturing CP, forcing the drawdown of back up lines of credit (from banks) to fund the shortage. Issuers started to replace some their CP issuance with longer term bonds and interest rate swaps if they needed floating rate borrowings.

      Companies, especially non bank finance companies used CP instead of bank loans because it was cheaper (all in).

  4. middleoftheroaddem

    The issuer of commercial paper often wants collateral. For example the paper is used to open a new factory: the machines in the new factory serve as collateral.

    As the US economy migrates more to services, the role for commercial paper seems to decline.

    1. KJK

      Commercial Paper is always unsecured, and issued by high investment grade companies, with non bank financial companies the most common issuer. The term for CP is 270 days or less and is issued with a discount, to generate a return. Issuers would have a back up line of credit from banks, so that if the CP could not be rolled over, the bank line would be drawn to fund the payment. For high investment grade issuers, the bank lines would also not be secured, though would contain covenants and a perhaps a prohibition on pledging any collateral to other lenders.

      Perhaps the decline is based on increased issuance costs required by money market funds and there may be less non bank finance companies now than before the Great Recession.

      2. middleoftheroaddem

        KJK - many years ago I was involved in a firm that issues asset backed commercial paper. I know, at least on occasion, commercial paper has colleterial.

        1. KJK

          Was it an ABCP secured by receivables or similar liquid assets, funded through a structured vehicle, or was it secured by plant, equipment, and buildings?

          The company I worked for about a decade+ ago was a non bank financial company and had over $100 billion of CP funding prior to the Great Depression, and was, at that time, the largest CP issuer in the world.

  5. Goosedat

    "The Commercial Paper Funding Facility (CPFF) was created in October 2008 to provide a liquidity backstop to U.S. issuers of commercial paper. The CPFF was designed to improve liquidity in short-term funding markets and thereby contribute to greater availability of credit for businesses and households."

    My recollection is the need for commercial paper was used an as issue to justify the bank bailouts of 2008 by all supporters of this type of relief.

    1. skeptonomist

      The CPFF was specifically for asset-back paper and was itself a bailout for shadow banking and other financial operations, not "(non-financial) businesses and households". I think that the Fed was deliberately obtuse about this, and the financial media generally bought what the Fed said.

  6. E-6

    True, I don't care about commercial paper trends. What I do care about is that you're well enough to be posting! May the recovery continue!

  7. skeptonomist

    There are various kinds of commercial paper. Asset-backed paper, specifically that backed by bundled mortgage assets, was used to finance the "shadow banking" industry. When the housing bubble collapsed so did that backing and this caused what was called a freeze in commercial paper in 2008, but it really only involved asset-backed paper. The Fed bought hundreds of billions of this kind of paper to keep the shadow banking industry from collapsing.

    So to know what is going in the commercial paper business you have separate the different kinds. Is the shadow banking business still going strong? This may not be known very well because the industry is not regulated.

Comments are closed.