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Banking Relations

Repo Turmoil Poses Moderate Risk as Corporate CP Grows

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November 06, 2019

BankingThe recent supply imbalance in US repurchase agreements (repos) agitated short-term financial markets, with many concerned about corporate issuers’ credit risk. But Fitch Ratings says not to worry unless the dislocations drag on.

Several factors prompted the imbalance, including the Federal Reserve’s balance sheet wind down, seasonal cash withdrawals from money market funds and banks for tax purposes, and increasing US Treasury issuance to finance the growing US deficit, according to Fitch. It adds that the dislocation resulted in the repo market “modestly” impacting CP yields as “lending rates across all short-term durations spiked in tandem with the repo rate but at a lower extreme.”

The corporate impact. The weekly average overnight rate for AA-rated, nonfinancial CP rose to 2.55% for the week ended Sept. 20 from 2.09% the week before, according to Fitch, and fell to 1.91% the week after, when the Fed offered repo loans to inject liquidity and normalize borrower rates.

While it doesn’t foresee further CP market disruptions, Fitch notes the recent turmoil as a reminder that corporate access to the short-term debt can be compromised or their rates may rise, especially when quarter-end repo market imbalances threaten to spill into other funding markets. “A prolonged period of market destabilization could result in increased rollover risk due to short-term one-day to 90-day maturity dates for CP,” the rating agency says. “Corporate cash flow could also be moderately affected if interest costs increase as a result of accessing other forms of higher cost capital to repay the CP or to boost liquidity.”

Make sure backstops are in place. Fitch notes that contagion risk from pressure in the repo market exists for the CP market because money market funds are a key investor base for both forms of short-term borrowing. Consequently, disruptions in the repo market that impact those funds can carry over to CP. Fortunately, notes Fitch, corporate CP issuers generally have committed revolvers that serve as credit support for investors and a backup source of liquidity if there is a disruption in low-cost, short-term funding availability. The rating agency adds that many of those investors also carry cash balances in excess of CP outstanding.

CP rising. Fitch notes that nonfinancial CP has more than tripled since the financial crisis—to $317 billion from $101 billion in total, and to $243 billion from $65 billion for domestic only. Pfizer’s CP balance, for example, jumped to $6.7 billion as of June 30, up from $3.1 billion at the end of last year. However, it has a $7 billion revolver backstop as well as $1.8 billion in cash and equivalents.

Greater risk. Companies whose CP is a large percentage of their capital structures could have difficulty terming it out during a period of market stress. Fitch notes that Coca-Cola’s outsized CP balances reached as high as 50% of total debt in 2014-2015—a ratings consideration—but said it has since moved to a “more balanced capital structure.”

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