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Subprime woes infect commercial paper market

KKR Financial, Thornburg, Coventree among firms reporting disruptions

By Alistair Barr, MarketWatch
Last Update: 6:14 PM ET Aug 15, 2007

SAN FRANCISCO (MarketWatch) -- Subprime mortgage problems have spread across so much of the credit market that they've begun to cause disruptions in the commercial paper market, which provides a lot of the short-term fuel that keeps corporate America running.

Companies including Coventree Inc. (CA:COF: news, chart, profile) , KKR Financial (KFN:TMA10.56, +2.95, +38.8%) have warned of problems in the commercial paper market in recent days. Such warnings are making analysts and investors nervous about other companies that use this source of funding, such as mortgage giant Countrywide Financial (CFC:
Countrywide Financial Corp

"The turbulence in subprime mortgages has now spread to the commercial paper market -- a $2.2 trillion market in the USA that is the working capital lifeblood for the corporate sector," David Rosenberg, North American economist at Merrill Lynch, wrote in a note to clients on Wednesday. "This is looking worse than just another credit cycle."

Rosenberg is a noted bear who's been warning about the economic effect of a housing slowdown for some time. However, such concerns knocked equity markets on Wednesday, pushing the Dow Jones Industrial Average.

The equity benchmark has dropped more than 5% during the past five trading sessions. The Standard & Poor's 500 Index dropped into negative territory for 2007 on Wednesday.

The commercial paper market usually allows creditworthy companies to borrow money on a short-term basis efficiently. It's easier than issuing other types of debt and can be a low-cost alternative to bank loans. Because of these attributes, the market has grown into one of the most important debt markets in the U.S.

However, signs of problems in this crucial market have begun to emerge in recent days.

Coventree, a Canadian company that sponsors and oversees roughly $16 billion of asset-backed commercial paper vehicles, said earlier this week that it couldn't sell new debt to refinance $950 million of short-term loans, some of which were maturing. Coventree shares slumped more than 70% on Tuesday.

The company said on Wednesday that it was able to sell roughly $600 million of asset-backed commercial paper, but it still had to extend the maturity on roughly $60 million of debt.
Rating agency DRBS said that it had been told by a number of Canadian companies on Tuesday that disruptions in the asset-backed commercial paper market were continuing. By the end of Tuesday, 16 companies had claimed a so-called market disruption event and asked for funding for debt that was maturing that day, the agency noted.

Merrill's Rosenberg noted on Wednesday that more than half of the commercial paper market is backed by residential mortgages, credit card receivables, car loans and other bonds.
"Now the rating agencies have warned that they might downgrade several issuers of commercial paper," he wrote.
Disruptions in this market may be hitting mortgage-related companies the hardest.

KKR Financial , a specialty finance company affiliated with buyout giant Kohlberg Kravis Roberts & Co., said on Wednesday that it could lose more than $200 million from leveraged investments in mortgage-backed securities. See full story.
Part of the problem has been "unprecedented disruption" in global commercial-paper markets, the company said, noting that it was talking with investors about alternatives to resolve potential funding issues. KKR Financial shares slumped 31% on Wednesday.

Thornburg, a leading mortgage lender that focuses on jumbo, adjustable-rate home loans, said late Tuesday that there have been disruptions in the company's ability to fund its mortgage assets in commercial paper and the asset-backed securities markets. It's shares dropped 47% on Tuesday. See full story.

Thornburg shares recovered strongly on Wednesday after Chief Operating Officer Larry Goldstone said on CNBC that the company has been negotiating with lenders, expanding some of its credit lines and paying off maturing commercial paper. See full story.
Still, Goldstone noted that it remained very difficult for mortgage companies to access the commercial paper market. And Thornburg shares are still down more than 65% in August.
Such disruptions have sparked concerns about other mortgage companies, especially Countrywide, the largest home loan originator in the U.S.

Merrill analyst Kenneth Bruce cut his rating on Countrywide to sell from buy on Wednesday, citing potential funding problems in the asset-backed commercial paper market. Countrywide shares dropped 13%.

"The recent disruptions in the asset-backed commercial paper market, as highlighted by the Coventree situation in Canada, is further eroding confidence in the markets that companies can effectively roll over short-term funding facilities," Bruce wrote.

"This forces finance companies, like Countrywide, to tie up more equity and has led to defaults at other mortgage finance companies," he added.

Less than a week ago, Bruce had reiterated his buy rating on Countrywide. But on Wednesday, he said the rapid deterioration in commercial paper and mortgage-backed securities markets changed his mind this week.

"Recent problems in the asset-backed commercial paper and non-GSE repurchase markets raise the risk that lenders reduce exposure to the mortgage sector, possibly causing Countrywide to de-lever into a weak market," Bruce wrote. "We had known this possibility existed, however, it appears funding markets are deteriorating quickly."

Alistair Barr is a reporter for MarketWatch in San Francisco.

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