By Paul J. Davies, Anna Isaac and Caitlin Ostroff
The normally staid corner of Wall Street where companies and
banks borrow money for days or weeks at a time was suddenly at the
center of a near financial meltdown last month. Some fund managers
are concerned that problems remain despite the quick work of
central banks to ease the funding strains.
Known as commercial paper, this more than $1 trillion market of
short-term loans, used by companies to cover expenses such as
payroll and paying suppliers, froze during March's
coronavirus-induced mayhem.
One problem, say market participants: Trading was dominated by a
limited cast of big investors who were seeking to sell big slugs of
commercial paper through a smaller number of banks that arrange the
financing, known as dealers. This led to bottlenecks.
"Like eight elephants trying to fit through three small doors,"
said David Callahan, head of the money-market management team at
Lombard Odier Investment Managers.
The Federal Reserve acted on March 17 to prop up money-market
funds, the main investors in commercial paper. A Fed lending
facility was immediately used by Goldman Sachs Group Inc. and Bank
of New York Mellon Corp. to swap commercial paper held in funds
they managed in exchange for cash.
The extent of the freeze shocked money-market fund managers.
"Like: Wait a minute, you don't have a bid on anything?" said Tim
Robey, manager of Eaton Vance's in-house money-market fund, which
manages spare cash on behalf of the investment firm's wider group
of mutual funds.
Although trading has restarted, commercial-paper borrowing rates
remain elevated. In late February, highly rated banks and companies
would pay a few tenths of a percent more than base interest rates
to borrow for three months. Those rates spiked to more than 2
percentage points in March, higher than the 1.5-percentage-point
peak in 2008, during the last financial crisis, according to
Goldman Sachs analysts. Rates have remained volatile, but as of
Friday were about 1.2 percentage points above base rates.
With commercial-paper markets closed off, companies looked
elsewhere for cash. Some raised longer-term debt in the bond
markets, which can be more costly. Others, such as Boeing Co. and
Anheuser-Busch InBev SA, drew on credit lines, a form of backup
borrowing. The unexpected rush of credit-line borrowing taxed
banks' balance sheets, limiting how much they could lend
elsewhere.
It also matters for the wider financial system. Banks are paying
higher rates on the commercial paper and similar instruments that
they use to borrow money short term. This leads directly to high
levels of Libor, the London interbank offered rate, the benchmark
in setting borrowing costs on trillions of dollars in mortgages,
commercial loans and derivatives.
Commercial-paper markets melted down in the 2008 financial
crisis, requiring a Fed bailout. Major changes in financial
regulation since then, meant to protect investors and the financial
system, may have left the market vulnerable.
Regulations that require banks hold more capital to back their
assets have made them reluctant to carry inventories of stocks or
bonds or commercial paper, even during normal market conditions. At
times of stress, like last month, they quickly ran out of space to
hold even small amounts of inventory, hampering their ability to
act as middlemen in the market.
Because trading in commercial paper is a low-margin business,
scale matters. That has helped the biggest banks win more market
share and means more business is done by fewer institutions,
according to investors and bankers involved in the commercial-paper
market.
The market has become more concentrated with a smaller number of
big dealer banks, including Bank of America Corp., JPMorgan Chase
& Co., Citigroup Inc. and Goldman Sachs; and big fund managers,
such as Fidelity Investments and Vanguard Group.
The other big change since the last crisis: In the past,
money-market funds reported a fixed $1-share price, with many
investors assuming institutions would stand behind the value no
matter what. New regulations came in 2016 that forced money-market
fund managers to report share prices that went up and down in line
with their assets. This was a reaction to the 2008 crisis, when the
Reserve Primary Fund became the first to "break the buck," lowering
its share price below $1 after Lehman Brothers commercial paper it
held became worthless.
That change may have made commercial-paper money-market funds,
also known as prime funds, more susceptible to outflows. Investors
may also remember the events of 2008 and have simply become more
wary about the risks of stashing cash in prime money funds.
Investors have sucked out $150 billion, or a fifth of assets
from prime funds, since late February. With less money sloshing
around, the cost to borrow in commercial paper markets jumped.
Much of that cash instead flowed into an even safer flavor of
money-market funds, which invest solely in short-term Treasury
bills and other government-backed debt. Those funds have grown by
nearly $1 trillion, increasing their total assets by more than a
third.
Those inflows played havoc with short-term Treasury markets,
pushing yields on three-month bills into negative territory on
March 26. Fidelity Investments, one of the leading money-market
fund managers, closed three of its Treasury-only funds to new
investors so that it wasn't forced to keep investing in
money-losing paper.
Some are skeptical that rates will return to normal despite the
Fed intervention. One of the Fed's programs buys new commercial
paper from companies and banks that had top credit ratings when the
program was announced last month.
That excludes lower-rated companies such as Marriott
International Inc. that need cash the most, said Eaton Vance's Mr.
Robey. Marriott said on March 8 that it had drawn down $2.5 billion
from a revolving credit facility to support repayment of commercial
paper. Marriott didn't respond to requests for comment about its
current access to the markets.
"It's the tier-two guys: They're the ones that will need the
cash," said Mr. Robey.
Write to Paul J. Davies at paul.davies@wsj.com, Anna Isaac at
anna.isaac@wsj.com and Caitlin Ostroff at
caitlin.ostroff@wsj.com
(END) Dow Jones Newswires
April 20, 2020 08:48 ET (12:48 GMT)
Copyright (c) 2020 Dow Jones & Company, Inc.