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Capital Markets

Tier-3 CP Market Remains Small but Offers Liquidity—For Now

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May 06, 2019

Steady economic output and favorable financial conditions could boost the market’s size and efficacy.  

Bond3The relatively small market for commercial paper (CP) issued by companies with the lowest investment-grade ratings (BBB-minus/Baa3) appears stable in the foreseeable future and might even grow, according to MUFG. That’s good news for some of the participants who discussed capital structure at a recent meeting of NeuGroup’s Treasurers’ Group of Thirty. 

Half a billion. The so-called tier-3 CP market—for issuers at the low end of the investment-grade spectrum with short-term credit ratings of A3, P3 or F3—will support CP programs of about half a billion dollars. That’s according to bankers consulted by one of the members. “They tell us that right now, in the current market, we could run $500 million,” the treasurer said in response to a question from a peer considering what will happen if his company is downgraded a notch.  

Half a billion dollars sounds about right to Stephany Bushweller, head of short-term credit products at MUFG, who said the bank generally guides clients that they can expect $500 million or so in liquidity in the tier 3 market.  

"Having said that, a company’s actual market access will depend upon a number of factors: Is the CP issuer a household name?  How volatile is the industry in which the issuer operates? Has the issuer assured investors of their commitment to keeping an investment grade rating?” Ms. Bushweller said. 

She added that clients have achieved programs greater than $500 million in the tier-3 market, and one MUFG client has more than $1 billion in CP outstanding. 

Small size, short maturity. Another T30 member noted that the tier-3 market is small—only about $8 billion. Indeed, Ms. Bushweller said that historically the market has been too small to track, and MUFG estimates its current size at $10 billion to $15 billion. She added the bank has been discussing the “efficacy of the [CP] market with a number of clients whose CP would be rated A3/P3/F3, so we expect the market size to grow.” 

Ms. Bushweller noted CP’s ‘in-full and on-time” investors, whose primary goal is principal preservation, with many having charters that do not permit investing in CP rated below investment-grade.To mitigate the risk of a downgrade forcing them to sell below investment-grade positions, investors tend to keep tier-3 CP maturities quite short. 

“A majority of the liquidity is overnight to one-month, with a typical weighted average maturity of less than two weeks,” she said. “So tier-3 CP programs have higher rollover risk than tier-2 or tier-1, and can require more staff time to manage, given that issuers tend to be in the market every day.” 

The outlook. Ms. Bushweller said more downgrades of companies now in the tier-2 market as well as new entrants could increase the size of the tier-3 market, adding MUFG believes positive economic and credit-market conditions will continue to encourage buyers of tier-3 CP. 

Alternatively, strain in the overall credit markets, such as widening spreads, would negatively impact appetite for tier-3 CP,” she said. “And certainly, a cliff default of a tier-3 CP issuer would cause investors to reevaluate their appetite. MUFG believes the risk of either scenario occurring in the near-term is de minimis.” 


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