Google Leads Revival in Commercial Paper as Rates Tumble: Credit Markets

Google Inc., owner of the most popular Internet search engine, and Germany’s Merck KGaA are leading a revival in commercial paper as nonfinancial companies grab the biggest share of the $1.1 trillion U.S. market from banks since 2002 amid lower borrowing costs.

Industrial borrowers have $151 billion of debt typically due in 270 days or less, up 47 percent this year and 14 percent of the total outstanding, seasonally adjusted Federal Reserve data show. Google, based in Mountain View, California, started a CP program last month for as much as $3 billion, while Merck helped fund its acquisition of Millipore Corp. in July with the debt.

Three years after the market froze, contributing to the worst financial crisis since the 1930s, the surge in so-called CP issuance may signal that companies are confident the U.S. will avoid slipping back into recession. The highest-rated non-bank issuers pay an annualized 0.27 percent for 90-day paper, compared with an average of 1.94 percent over the past 10 years.

“There’s a sense of confidence in the market,” said Chris Conetta, head of global commercial paper at Barclays Capital in New York. “It’s just so cheap for non-financial borrowers that it’s attracting some back to the market.”

Corporate spending on equipment and software jumped an annual 22 percent in the second quarter, the biggest increase since 1997 and after a 20 percent gain in the first three months of the year, the Commerce Department said July 30.

Cheap Rates

Google, Darmstadt, Germany-based Merck and more than a dozen other companies have said they boosted their use of CP to take advantage of the cheap rates to refinance more expensive debt, fund acquisitions and meet day-to-day expenses.

Elsewhere in credit markets, the extra yield investors demand to hold corporate bonds rather than government securities widened after falling for five straight weeks. Sales of the securities worldwide declined 14 percent and the rally in U.S. mortgage bonds came to an end.

Corporate bond spreads widened 2 basis points last week to 177 basis points, or 1.77 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate index. The gap is up from this year’s low of 142 basis points on April 21 before rising to as much as 201 basis points June 11. Yields fell to 3.59 percent, from 3.66 percent Aug. 6.

American General

American General Finance Inc. bonds were among the biggest losers, plummeting last week on concern that Fortress Group LLC will seek to restructure its debt after purchasing the consumer lender from American International Group Inc.

American General’s $3 billion of 6.9 percent notes due in 2017 had their biggest weekly drop since September 2008, the month after its parent was rescued from the edge of bankruptcy by the U.S. government. The securities declined 11.75 cents to 78 cents on the dollar, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Credit-default swaps in the U.S. and Europe rose last week after falling for three straight weeks.

U.S. Swaps

The Markit CDX North America Investment Grade Index of credit-default swaps, which investors use to hedge against losses on corporate debt or speculate on creditworthiness, climbed 4.3 basis points to 108.4 basis points, according to Markit Group Ltd.

In London, the Markit iTraxx Europe Index of swaps on 125 companies with investment-grade ratings increased 9.6 basis points in the week to 113.1, the biggest weekly increase since the period ended May 21.

Both indexes typically rise as investor confidence in the credits deteriorates and decline as it improves. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Corporate bond sales declined to $54.3 billion, compared with $63.2 billion in the period ended Aug. 6, according to data compiled by Bloomberg. That’s the least since the week ended July 23, when issuance was $49.7 billion.

Mortgage Bonds

U.S. mortgage bonds with government-backed guarantees, whose prices climbed to a record last month, slumped last week on speculation U.S. policy makers will seek to accelerate homeowner refinancing. Owners of the $5.2 trillion of securities have lost 0.156 percent in August, headed toward their first negative monthly returns since December, according to Bank of America Merrill Lynch index data.

“The recent debate about the government interfering with the mortgage market, and potentially ‘engineering’ a refi wave, has got mortgage investors spooked,” Brian Ye, a mortgage-bond analyst at JPMorgan Chase & Co. in New York, said in an e-mail. “And now they’re on strike.”

The S&P/LSTA US Leveraged Loan 100 Index fell 0.25 cent to 89.58 cents on the dollar, the first weekly drop since the period ended July 2. The index is up 2.16 percent this year.

Casino Loan

Las Vegas Sands Corp., the casino company controlled by billionaire Sheldon Adelson, got lender approval to extend and repay a portion of a U.S. term loan that had covenants restricting its use of cash. Credit Suisse Group AG arranged the agreement that will extend part of the $4 billion loan by 2 1/2 years in exchange for a higher interest rate and debt repayment, said four people familiar with the matter. The amendment won’t affect its Macau and Singapore borrowings.

In emerging markets, the yield spread on company bonds rose 6 basis points last week to 275 basis points, the highest since July 30, according to JPMorgan index data. The gap has climbed from 258 basis points on Aug. 9, which was the lowest since April 30.

The CP market’s rebound this year signals confidence in the economy. The median estimate of 64 economists surveyed by Bloomberg News this month is for growth of 3 percent in 2010 and 2.8 percent in 2011. The lowest forecast was 1.8 percent growth this year and 1.4 percent next.

‘Lull’ Before Recovery

“At a global level, we continue to view the recent softening as a lull before a subsequent resumption of activity, rather than a prelude to a major slide,” Julian Callow, chief European economist at Barclays Capital in London, wrote in a report dated Aug. 13. “The confidence of CEOs of major global companies appears still to be positive, buoyed by positive earnings reports, lean inventories, and balance sheets.”

Concern that the U.S. economy’s rebound is waning increased last week as the Fed said Aug. 10 the recovery would be more “modest” than anticipated. Goldman Sachs Group Inc., one of the 18 primary dealers that trade directly with the central bank, said three days later that there’s a 25 percent to 30 percent chance of another recession in the world’s largest economy. Even so, the bank said a “double-dip” isn’t its “base case” scenario.

Outstanding CP

The amount of nonfinancial CP outstanding retreated last week from a 14-month high of $156 billion on Aug. 4, Fed data show.

The seizure of the market was one of the driving forces behind the worst credit crunch in decades as issuance fell by about 50 percent to $109 billion in the nine months following Lehman Brothers Holdings Inc.’s bankruptcy in September 2008.

At the time, investors shunned asset-backed CP from issuers that used the debt to finance purchases of souring subprime-mortgage assets. Lehman’s bankruptcy then sparked a run on money-market assets after the $62.5 billion Reserve Primary Fund fell below $1 a share, or “broke the buck.” The oldest money-market fund, which held $785 million in Lehman debt, is being liquidated.

Companies couldn’t sell short-term debt as investors stopped buying new issues. About $744 billion was pulled from prime money funds in the three weeks following Lehman’s collapse and so-called second-tier 30-day CP rates doubled to 6.02 percent within three days. At least 36 funds in the U.S. and about 26 in Europe had to be propped up by governments, Moody’s Investors Service said Aug. 9.

Boosting Spending

The rebound in CP issuance now shows companies are more comfortable that there will continue to be buyers for the debt as they boost business spending, according to Conetta of Barclays.

“It feels to me like it’s a sustained trend,” Conetta said. “The fears in 2008 and 2009 that led so many non-financial issuers to term out have abated and people feel more comfortable issuing.”

U.S. money-market funds, the biggest buyers of CP, are on pace for their first monthly increase in assets since January 2009, according to Investment Company Institute, a Washington-based group that represents mutual funds. Total assets have increased $22.2 billion in the past three weeks to a month-high of $2.82 trillion, the trade group said.

Rates Double

Money-market investors are buying more CP because rates are double the 0.1 percent that the 100 biggest funds make on average across their holdings, according to Peter Crane, president of Crane Data LLC, a money-fund research firm in Westborough, Massachusetts.

“Any uptick in issuance is a sign of health,” said Crane. “The demand side has firmed.”

Google started its CP program, backstopped by a revolving-credit facility, to create a “more capital- efficient capital structure that will provide us with low- cost working capital availability and flexibility,” Chief Financial Officer Patrick Pichette said on a July 15 conference call to discuss second-quarter results. “It’s also an excellent time to do it given the historically low interest rates,” he said.

Merck raised $400 million through CP to help finance its $6 billion acquisition of biotech equipment supplier Millipore at a cost of “near to nothing,” CFO Michael Becker said July 29.

Oneok Partners LP, a Tulsa, Oklahoma-based pipeline operator, put in place a $1 billion CP program in June to reduce bank borrowings, CFO Curtis Dinan told analysts on an Aug. 4 conference call. Paying down its revolving-credit facilities in July cut the cost of servicing Oneok’s short- term borrowings by about 25 basis points.

Repsol YPF SA, the largest Spanish oil company, said it refinanced a 945 million-euro ($1.2 billion) bond in May that cost 4.5 percent annually, issuing CP at a “very competitive” rate of as much as 5 basis points more than benchmark rates.