Coca-Cola Flees Commercial Paper for Safety in Bonds

Coca-Cola Co. is fleeing commercial paper for the safety of long-term bonds.

The world’s largest soft-drink maker joins a growing number of borrowers reducing their dependence on the debt this year as the market sinks to its lowest since seizing up after Lehman Brothers Holdings Inc. collapsed in September.

Coca-Cola, health-insurer WellPoint Inc. and more than 30 other companies are issuing bonds and using the proceeds to repay their short-term IOUs, according to data compiled by Bloomberg. The amount of commercial paper outstanding shrank 16 percent since Jan. 7 to $1.48 trillion last week and daily issuance dropped to a four-year low, according to the Federal Reserve.

“People want to push down their debt levels, build up their cash war chests and have lots of sources of funding, just in case one of the legs of their stools gets kicked out,” said Peter Crane, president of Crane Data LLC, a money-fund tracking firm in Westborough, Massachusetts.

By lessening their reliance on commercial paper, borrowers are paying higher interest rates to avoid the risk of not being able to roll over the debt every few weeks. With the gap between short- and long-term debt rates the widest in at least two decades, the cost of swapping $1 billion of 30-day paper with long-term debt can cost more than $75 million in additional annual interest, Merrill Lynch & Co. and Bloomberg data show.

Recession Extension

A lack of confidence in commercial paper, which matures in nine months or less and is used to meet everyday expenses such as payrolls, may extend the worst U.S. recession since at least 1982 because treasurers will lose the ability to raise cash quickly and cheaply, said Adolfo Laurenti, senior economist at Mesirow Financial Inc. in Chicago.

The economy will likely contract 1.8 percent this year, after expanding 1.1 percent in 2008, according to the median estimate of 65 economists surveyed by Bloomberg.

An increase in the premium banks charge each other for short-term loans, the so-called Libor-OIS spread, shows how commercial-paper refinancing risks are rising. The gauge of bank reluctance to lend climbed to a nine-week high of 1.08 percentage points March 13 from a four-month low of 0.89 percentage point Jan. 15. It has since eased back to 1.07 percentage points.

WellPoint, the largest U.S. health insurer by enrollment, sold $1 billion of 5- and 10-year notes Feb. 2 at rates as high as 7 percent to repay commercial paper with an average yield of about 2 percent, according to Chief Financial Officer Wayne DeVeydt. The move by the Indianapolis-based company cut outstanding short-term debt to about $500 million, he said.

“What we’ve really done is hedged against another crash in the CP market,” he said.

‘Incredibly Dangerous’

Reliance on short-term credit is “incredibly dangerous,” DeVeydt said. “If you have another run on the bank, which is really what happened to many companies in the fourth quarter of last year, you’re not going to get access to other long-term debt.”

Corporate bonds rated A yielded 8 percent on March 11, or 7.47 percentage points more than short-term debt due in 30 days and ranked A-1/P-1/F1, according to Merrill and Bloomberg data.

Companies are taking advantage of recent demand for investment-grade bonds that pushed borrowing costs for A rated borrowers to below 7 percent in February from a 17-year high of 9.6 percent Oct. 30, Merrill data show. Non-financial companies sold more than $142 billion this year, a record pace, according to Bloomberg data.

The commercial paper market contracted $280 billion in the past nine weeks, and is down from a peak of $2.22 trillion in July 2007, Fed data show. Non-financial paper outstanding fell $35.1 billion to $188.7 billion in the same period.

Lesson Learned

“Everyone learned the lesson” from Lehman’s demise, Laurenti said.

The risk that a solvent company loses access to short-term debt and goes under “is high in everyone’s mind,” he said. “So unless you really have to, why go to the commercial paper market?”

Restoring confidence in commercial paper is one way policy makers aim to fix credit markets. The Fed started purchasing unsecured and asset-backed commercial paper directly from companies on Oct. 27. At the peak in January, the Fed shouldered the risk for $365 billion of commercial paper, central bank data show. The total is now $247 billion.

Financial firms are replacing some commercial paper with notes backed by the Federal Deposit Insurance Corp., Crane said. The companies, which lost access to the bond market last September, have sold $209 billion of FDIC-backed bonds since Nov. 25, Bloomberg data show. The FDIC guarantee can also be used to sell commercial paper.

General Electric Notes

General Electric Co. cut its financing arm’s commercial paper borrowing by about a third to $60 billion this year as part of a plan to reduce overall debt. At the same time, GE Capital Corp. sold $36.6 billion of FDIC-backed notes, Bloomberg data show.

The company, which lost its AAA rating at Standard & Poor’s last week and is now ranked one step lower at AA+, sold commercial paper at “favorable” rates throughout the market seizure, GE spokesman Russell Wilkerson said.

Switching from commercial paper to bonds will boost the economy and improve corporate balance sheets, said James Merli, head of U.S. debt syndicate at Barclays Capital Inc. in New York.

“If you’re a treasurer or a CFO, you’d rather have more stable sources of funding,” he said.

Coca-Cola sold $2.25 billion of 5- and 10-year notes March 3 to repay maturing commercial paper, Bloomberg data show. The Atlanta-based company agreed to pay as much as 4.875 percent to replace short-term debt with an average yield of 0.41 percent, according to a regulatory filing.

‘Continued Concern’

The difference amounts to about $48 million in extra annual interest on every $1 billion borrowed and used to replace commercial paper. Coca-Cola had $5.4 billion of paper outstanding as of Dec. 31.

Part of Coca-Cola’s reason for reducing long-term debt related to “continued concern about financial institutions’ situations,” spokesman Dana Bolden said in an e-mail. “We continue to have a sizable commercial paper balance outstanding and are seeing our commercial paper program functioning very well.”

The market for commercial paper backed by assets such as auto loans and credit cards seized up in August 2007 at the beginning of the credit crisis as defaults on subprime home loans began to soar. It fell 37 percent over five months to $772.8 billion, from its peak in August 2007 of $1.22 trillion.

Breaking the Buck

After Lehman filed for bankruptcy on Sept. 15, the broader market froze. The next day, the flagship $62.6 billion money- market fund of Reserve Management Corp. became only the second of its kind to break the buck as its net asset value fell below $1-a-share because of its stake in Lehman’s commercial paper

Non-financial investment-grade companies face higher refinancing risk because of a weakening economy and tightened credit markets, according to a Moody’s Investors Service report yesterday. In addition, debt-rating cuts may restrict access to short-term borrowings from investors, Crane said.

Newark, New Jersey-based Prudential Financial Inc., the second-largest U.S. life insurer, and Genworth Financial Inc. lost access to the Fed’s commercial paper facility after their short-term debt ratings were cut to second tier.

Kicked Out

Genworth said it borrowed $930 million from one of its revolving credit lines three days after the Richmond, Virginia- based company said it was ineligible to participate in the Fed’s facility. Many companies with second-tier ratings have been unable to sell commercial paper, with issuance plunging by more than half from seven months ago, Fed data show.

Pitney Bowes Inc., the world’s largest maker of postal meters, raised $300 million on March 2 in an offering of 6.25 percent notes to repay commercial paper and “take some of that risk off the table,” said Helen Shan, vice president and treasurer of the Stamford, Connecticut-based company.

“What we are concerned about is really the uncertainty,” Shan said. “We don’t know where things will be for the rest of the year. I wish I did.”