Commercial paper (CP) is a short-term, unsecured promissory note issued by corporations typically used as a source of working capital, receivables financing, and other short-term financing needs. Originally the CP market was available as a funding source to only the highest credit quality entities.CP has maturities ranging anywhere from 1 to 270 days. However, innovations such as liquidity programs, credit enhancements, and various special legal structures have made CP a viable financing alternative for entities with lower credit ratings.
These multiseller ABCP programs issue CP backed by the cash flows from all the underlying assets.
The goal of such multiseller Programs is to enjoy the diversification from multiple sellers of various industries.
With ABCP, certain assets such as credit card receivables or auto loans and their cash flows, support a specific CP issue.
ABCP is usually sold through a conduit, a special purpose vehicle (SPV) established to facilitate the financing. Some SPVs pool the assets of many entities from various industries.
Typically, governments purchase CP with a buy and hold approach until maturity strategy. During market disruptions, investors face the scenario where issuers will be unable to issue new CP to refinance the maturing commercial paper and the secondary market disappears.
While a secondary market exists that can be utilized for sales prior to maturity, there have been periods of disruption due to either issuer-specific events or as a result of a broader market wide disruption. To mitigate this risk, CP is usually backed by bank lines of credit.Single seller ABCP programs are backed by the assets of one entity, for example a corporation.Consequently, they lack the diversification of multi-seller programs.Firms normally examine cash flow at quarterly intervals.Following are the sources of short-term financing: For short-term financing need of a small business, commercial banks are a good choice.Most ABCP programs are partially supported programs, in which the program sponsor or guarantor may legally be obligated to cover only a certain percentage of defaults of the underlying assets or cover limited liquidity requirements related to delinquencies of these underlying assets.There are several programs still in existence that are fully supported, in which the program sponsor is obligated to reimburse CP investors regardless of delinquencies or defaults except in the case of a bankruptcy of the program.Banks provide three kinds of loans – Single, End-of-period Payment Loan (firms pay fixed or variable interest on the loan and payback the principal sum in lump sum at the end of the loan); lines of credit (a bank agrees to lend a company any amount up to a stated maximum – it may be committed or uncommitted line of credit.In India the line of credit is usually in the form of cash credit and banks charge interest only on the actual balance utilized; and floating charge is created in favor of the bank); and bridge loans (to bridge the gap until a firm can arrange for long-term financing – the lender deducts interest in the beginning from the loan proceeds).Nationally recognized statistical rating organizations (NRSROs) routinely rate commercial paper issues and regularly review the strength of the credit quality of the issue.In some instances, CP programs have been downgraded rapidly by the NRSROs.