More warnings on commercial paper:
Got credit crunch?
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February 26, 2001, 04:39 PM
NEW YORK (Reuters)
- Investors should beware of bonds sold by companies, such as original equipment automakers, that have mid single-A credit ratings and are heavily reliant on the commercial paper market, Merrill Lynch & Co. said in a report dated Friday.
Declines in corporate credit quality may steer many such companies out of the commercial paper market, and instead to sell more term debt, it said.
This shift, Merrill Lynch said, reflects a technical split in investor sentiment toward investment-grade debt depending on what kind of maturity is at issue.
Investor base implodes
"One interesting distinction between the long- and short-term credit markets is that the investor base loses its depth at different rating thresholds," said Merrill Lynch. "While the CP investor base implodes below A1/P1, or mid single-A, the term market generally holds the same investor base until low triple-B." Commercial paper is short-term debt with a maturity of 270 days or fewer. Term debt matures in one year or more.
Money market funds comprise much of the investor base in the $1.6 trillion commercial paper market. These funds are subject to Rule 2a-7 of the Securities and Exchange Commission, which is designed to insure that their net asset values do not fall below $1.
The rule classifies commercial paper rated below 'A-1' by Standard and Poor's or 'Prime-1' (sometimes called 'P-1') by Moody's Investors Service as 'Tier 2.' A fund cannot hold more than 5 percent of its assets in 'Tier 2' paper, or 1 percent of its total assets in a Tier 2 issuer.
In recent weeks, several companies, including DaimlerChrysler AG (NYSE:DCX) , France Telecom , Lucent Technologies Inc. (NYSE:LU) and Motorola Inc. (NYSE:MOT) have seen either Moody's or S&P, or both, cut their commercial paper ratings to below A-1/P-1, or else put them on review for downgrade to below that level.
The recent slide of several such ratings actually began in January, when corporate term debt was actually outperforming Treasuries. Yet at the same time, the yield gap between A-1/P-1 and A-2/P-2 commercial paper was unusually wide.
"The lesson from last month is that term investors should beware of divergent signals from the corporate and commercial paper markets," said Merrill Lynch. "Not only can heavy reliance on the CP market for funding be a financial problem for credits on downward ratings trends, but it can also be a technical problem -- more term supply."
In the last several months, Merrill Lynch said, many companies sold term debt or tapped credit lines because they found the commercial paper markets too unfriendly. In part as a result, outstanding non-financial commercial paper fell a record $25 billion in January, it said.
Beware of automakers
Given such trends and 'crowding' in short-term markets, Merrill Lynch said, "we recommend that investors beware of mid single-A credits that are reliant on the CP and bank loan markets."
To that end, Merrill Lynch recommends that investors be leery of bonds sold by DaimlerChrysler, Ford Motor Co. (NYSE:F) and General Motors Co. (NYSE:GM), or their finance arms DaimlerChrysler NA Holdings, Ford Motor Credit Co. and General Motors Acceptance Corp.
Ford Motor Credit had an average $27.1 billion of commercial paper outstanding last quarter, while General Motors Acceptance Corp. had $29.9 billion, said Merrill Lynch, citing Moody's. Both carry A-1/P-1 short-term ratings with a negative outlook from Moody's and S&P.
Merrill Lynch also recommended avoiding bonds of DaimlerChrysler, which had an average $17.8 billion of commercial paper outstanding last quarter. Merrill Lynch made its recommendation before Moody's and S&P on Monday cut the automaker's short-term debt ratings to 'A-2' and 'Prime-2,' respectively.
Other companies with high fourth quarter short-term debt loads, as provided by Moody's, and at least one A-1/P-1 rating with a negative outlook or on review for downgrade include: AT&T Corp. (NYSE:T), $26.8 million; British Telecommunications Plc (quote from Yahoo! UK & Ireland: BT.L), $5.5 billion, and Motorola, $4.2 billion.
Separately, as European telecoms' credit quality rapidly deteriorates, Merrill Lynch recommended that investors swap out of bonds of several European banks with high exposure to the sector, and into bonds of US banks. |
