The True Cost of Commercial Paper

In recent years, many large utilities established commercial paper programs backstopped by their global bank revolving credit facilities. These programs were intended to take advantage of the low interest rates prevailing in the commercial paper market. Commercial paper was viewed as an inexpensive and easily accessible route to satisfying short-term liquidity needs. Utilities expanded their use of commercial paper, usually to the exclusion of drawing down conventional revolving credit facilities.

But is complete reliance on commercial paper the right strategy, especially in the current environment?

A fresh look at the facts suggests not:

The true cost of commercial paper is higher than is apparent if one looks only at the commercial paper rate itself.

Once LIBOR rate differentials, unused commitment fees on the backstopping revolver, and agent fees are factored in, commercial paper is not a great bargain in comparison to a carefully structured revolving credit program that is drawn down as cash is needed. The current rising rate environment only lessens the perceived cost advantage of commercial paper.

Exclusive reliance on commercial paper carries significant risks.

Recent history shows that economic shocks can result in a sudden exit of buyers from the commercial paper market, driving volatility and making issuance prohibitively expensive or even impossible. There have been two occasions in just the last 20 years where even the highest quality commercial paper could not find a market: The Dot Com crash in 2001 and the Financial Crisis of 2008.

Diversifying liquidity sources to include local/regional Main Street financing can be a win-win on many levels.

On a pure cost basis, revolving credit is often as cost-competitive as commercial paper. Reduced reliance on commercial paper means less financing cost volatility in the event of economic shocks. Additionally, because local and regional banks do not face the same capital requirements as major Money Center banks, Main Street banks are often more reliable in meeting revolving credit drawdowns in periods of economic uncertainty. Local and regional financing also has the advantage of benefitting communities and generating goodwill with stakeholders, including regulators.

Once LIBOR rate differentials, unused commitment fees on the backstopping revolver, and agent fees are factored in, commercial paper is not a great bargain in comparison to a carefully structured revolving credit program that is drawn down as cash is needed. The current rising rate environment only lessens the perceived cost advantage of commercial paper.

Contact any of our team members to learn more about how a carefully structured regional/local commercial credit syndication can offset the risks of reliance on commercial paper as the main source of liquidity.

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