March 18, 2020 / 6:46 PM / 20 days ago

Cost to borrow commercial paper rises despite Fed intervention

NEW YORK, March 18 (Reuters) - The rate at which companies could borrow short-term loans increased on Wednesday, despite the Federal Reserve’s intervention Tuesday to backstop the market.

The Fed had said it would reinstate an operation used during the 2008 financial crisis called the Commercial Paper Funding Facility (CPFF) to get credit directly to businesses, as liquidity has dried up and prices have risen in the commercial paper market due to the coronavirus.

But costs did not ease on Wednesday despite the Fed’s entrance into the market as a lender of last resort. The composite interest rate for high-grade commercial paper was 11 basis points higher on Wednesday and 7 basis points higher for lower-grade commercial paper, according to Kevin Giddis, chief fixed income strategist at Raymond James.

The central bank’s announcement was made late in the morning on Tuesday, after the commercial paper market had effectively closed, so changes in the market would not have been felt until early Wednesday.

The spread between interest rates on lower- and higher-rated overnight commercial paper had increased on Tuesday to the widest level since 2008, signaling investors were demanding a hefty premium to hold riskier debt, according to Fed data.

“The commercial paper market is still having issues with the composite trading higher than yesterday, even after the announcement of the CPFF,” said Giddis.

“The cost of tapping that facility is expensive and a lot of companies can do better themselves,” he explained.

The price being offered by the Fed for high-grade paper is 200 basis points over the Overnight Interest Swap rate - steeper than some had expected. The high price may not make it meaningfully easier for some companies to tap the commercial paper market and therefore may not change liquidity conditions.

“We believe that the market was disappointed by the price set,” wrote Morgan Stanley analysts.

“This facility acts as more of a backstop for further widening as opposed to relief for current levels.”

The FRA-OIS spread USDF-O0X1=R, a proxy for risk in the banking sector, widened by about 4 basis points on Wednesday, after widening by more than 15 following the Fed announcement, as investors bet that companies will continue to draw on existing lines of credit at banks, potentially putting them under stress.

Companies including Boeing Co, Hilton Worldwide Holdings Inc and SeaWorld Entertainment Inc have drawn on lines of credit with banks in recent weeks.

The Trump administration on Wednesday proposed providing a backstop to money market funds, one of the biggest owners of commercial paper. But while such a measure “could be very helpful, it is also creating even more panic as the sense of urgency and sheer size of this increases,” said Giddis. (Reporting by Kate Duguid; editing by Megan Davies and Tom Brown)

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