Increase in Commercial Paper Issuance Is Positive Sign for Corporate Growth

Includes: DIA, SPY
by: Finance Banter

The Federal Reserve released data showing a $67 billion increase in commercial paper outstanding this week. This is the largest weekly expansion in almost a year. Growth in CP issuance indicates more favorable borrowing conditions for corporations and signals a positive trend for corporate growth.

The rise in issuance is a combination of low borrowing rates and increased investor comfort in corporate stability. Commercial paper is a short-term financing vehicle for corporations. It is commonly used to bridge the time gap between production and sales, or to meet operating demands such as payroll and rent. Retailers, for example, may issue commercial paper to purchase new inventory. When this inventory is sold, they use the proceeds to pay down outstanding commercial paper. For financial institutions, it can be used to finance loan commitments for borrowers as well as fund operations. By definition, commercial paper carries a short-term maturity of 270-days or less.

The commercial paper market all but shut-down late last year, leading to increased distress among corporations who relied on it to finance operations. Mortgage originators use a subset of the market called “asset-backed commercial paper” to fund outstanding loan commitments. As liquidity vanished for asset-backed loans late last year, so did commercial paper funding for originators. This, in turn, forced mortgage companies to hold loans they had intended to sell, or forced them to sell loans at a substantial capital loss. Consequently, potential borrowers saw the availability of credit evaporate overnight.

In the illustration below, you can see the growth of asset-backed commercial paper issuance that began in late 2004 and the steep decline that followed. Financial and nonfinancial paper also grew, but in a way that is consistent with economic growth – not as an unsustainable leap. Notice that the trend line for all sectors is beginning to rise once again – this is a bullish indicator for corporate investment and should lead to earnings growth.

CP Issuance
Source: Federal Reserve

Financial and non-financial companies are gaining better access to the short-term financing market, which will fuel investment. If corporate activity continues to expand, we should see commercial paper issuance maintain its move upward. Having access to financing markets is the essential fuel a company needs to increase operations and drive economic expansion.

Sources: Wall Street Journal, Bloomberg, Federal Reserve Board