Chapter 24 The Many Different Kinds of Debt 641
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Because investors are reluctant to buy commercial paper that does not have the highest
credit rating, companies cannot rely on the commercial paper market to provide them always
with the short-term capital that they need. For example, when the rating services downgraded
the commercial paper of Ford and General Motors, both companies were forced to sharply
reduce their sales of paper. Ford Credit had $45 billion of unsecured commercial paper out-
standing at the end of 2000; by 2011 it had effectively none.
When Lehman Brothers filed for bankruptcy in September 2008, the commercial paper
market nosedived. The spread between the interest rates on commercial paper and Treasury
bills doubled, while the market closed entirely for low-grade issuers. Many firms that found
themselves shut out of the commercial paper market rushed to borrow on their bank lines of
credit. For example, the CFO of the hotel giant Marriott reported that the company drew on
its $900 million revolver because it “decided it was prudent” to supplement the significantly
reduced liquidity in commercial paper. Firms that had no such alternative source of borrowing
were forced to cut back on their investment plans.^55 Only after the Fed announced plans to
buy large quantities of high-grade paper did the market begin to return to normal.
In addition to unsecured commercial paper, there is also a market for asset-backed
commercial paper. In this case the company sells its assets to a special-purpose vehicle that
then issues the paper. For example, as the auto companies reduced their sales of unsecured
commercial paper, they increasingly relied on asset-backed paper secured by the firm’s
receivables. As the customers paid their bills, the cash was passed through to the holders of
this paper.
By 2007 asset-backed paper accounted for almost half the commercial paper market, but
weaknesses surfaced after a number of banks set up structured investment vehicles (SIVs)
that invested in mortgage-backed securities financed by asset-backed paper. Because the
buyers of the commercial paper bore the credit risk, the banks had less incentive to worry
about the quality of the underlying mortgages. Once it became clear that this quality was
very low, many of the SIVs found it impossible to refinance the maturing paper and went
into default.
Medium-Term Notes
New issues of securities do not need to be registered with the SEC as long as they mature
within 270 days. So by limiting the maturity of commercial paper issues, companies can avoid
the delays and expense of registration. However, large blue-chip companies also make regular
issues of unsecured medium-term notes (MTNs).
You can think of MTNs as a hybrid between corporate bonds and commercial paper. Like
bonds they are relatively long-term instruments; their maturity is never less than 270 days,
though it is typically less than 10 years.^56 On the other hand, like commercial paper, MTNs
are not underwritten but are sold on a regular basis either through dealers or, occasionally,
directly to investors. Dealers support a secondary market in these MTNs and are prepared to
buy the notes back before maturity.
Borrowers such as finance companies, which always need cash, welcome the flexibility
of MTNs. For example, a company may tell its dealers the amount of money that it needs to
raise that week, the range of maturities that it can offer, and the maximum interest that it is
prepared to pay. It is then up to the dealers to find the buyers. Investors may also suggest their
own terms to one of the dealers, and, if these terms are acceptable, the deal is done.
BEYOND THE PAGEmhhe.com/brealey12eCommercial paper
and the financial
crisis(^55) For an analysis of firm reaction to the collapse of the commercial paper market, see P. Gao and H. Yun, “Commercial Paper, Lines of
Credit, and the Real Effects of the Financial Crisis of 2008: Firm-Level Evidence from the Manufacturing Industry,” working paper,
University of Notre Dame, 2010.
(^56) Occasionally, an MTN registration may be used to issue much longer term bonds. For example, Disney has even used its MTN
program to issue a 100-year bond.