CP’s flexibility and low cost beckon, but liquidity risk is a key reason one member says his company is avoiding it—for now.
What’s not to like about commercial paper (CP)? This popular form of unsecured short-term debt used in the capital structures of many companies for working capital and other purposes gives issuers a relatively inexpensive, cost-efficient source of funding. Members at a recent meeting of NeuGroup for Capital Markets sponsored by Wells Fargo agreed that CP also gives them flexibility, relative ease of issuance and a way to gain floating-rate exposure without the need to swap from fixed-rate debt.
- However, in introducing the session, Scott Flieger, NeuGroup’s senior director of peer groups and a former debt capital markets investment banker, noted that “companies look at the commercial paper market differently. There’s no right or wrong approach, there’s the approach that best suits the company.”
Optionality at a low cost. Flexibility is one reason CP suits one of the members who presented to the group. “If we wanted to raise $500 million tomorrow, we could do it and it’s pretty easy and it wouldn’t even take that long,” he said. “We’ve done that before. I think having that kind of optionality is pretty beneficial.”
- Other members also cited the flexibility CP gives them to cover costs for working capital fluctuations, small acquisitions and accelerated share repurchase programs. One member’s company has significantly increased its CP program in the last year and said it can serve as a “bridge” between debt issuances.
- Low cost is another major selling point. The weighted average cost for the presenting member’s outstanding CP is less than 50 basis points. “So it’s really cheap and it’s hard to ignore that for the low level of risk that we feel it presents our company. We’re trying to take advantage of that situation,” he said.
- One reason for that low risk: The company generates cash on a steady, consistent basis and has the ability to reduce capital expenditures during a liquidity crunch, the member said. And CP represents a small percentage of its total debt complex.
Weighing liquidity risk. But one member who works at a company with an unpredictable cash flow cycle and large, outgoing payments that it doesn’t want disrupted decided against starting a CP program after weighing the pros and cons over the last two years. The main con: liquidity risk.
- “It’s very attractive from a low-cost debt sampling, but for us, it adds liquidity risk,” this member said. “So it solves one problem while adding to the other problem. The part that we were really concerned about is that at the times when the CP market dries up is also the time when your liquidity is at most risk.”
- The lack of a smooth cash flow cycle at this company means CP cannot be viewed as simply covering cash flow gaps, he said. That made the decision about whether CP would replace other, permanent debt in the company’s capital structure.
- Given historically low borrowing costs, “it didn’t seem like the amount of savings we would get was worth the amount of risk and effort it would take to stand up a CP program,” he said. “I think as borrowing rates increase, as we move up in ratings to maybe A1/P1, that’s something would be more valuable.”
Where revolvers fit in. A Wells Fargo slide presentation on CP notes that credit rating agencies require that issuers maintain a “liquidity backstop” for outstanding CP notes. Most companies use revolving credit facilities (revolvers) to do this. The deck also says that the depth of market access for an issuer is “correlated to the level and stability of an issuer’s ratings.”
- One member whose company is considering a new CP program said she thinks of CP as low risk because it’s backed by a revolver. In response, the member whose company decided against CP said, “We look at our revolver as kind of a ‘break glass when needed’ event and that’s the time when we want to keep all of our revolver capacity available.”
- The member whose company issues CP said the company would not be alone if a situation arose where it could not “roll” its outstanding CP forward. “If it was so bad we needed to draw on our revolver to term CP, the signal that sends is the last of our worries in that scenario. At that point we feel everyone has an issue. The government is going to have to do something.”
- Indeed, members noted that the Federal Reserve stepped in to provide a liquidity backstop when the CP markets froze at the onset of the Covid pandemic in 2020. The presenting member said the minimal disruption meant only that his company could not issue CP in certain tenors that were not available or too expensive. “But it wasn’t like you can’t get things done, at least for us.”