Jan. 27 (Bloomberg) -- Seventeen months after seizing up at the onset of the credit crisis, the $1.69 trillion commercial paper market may be the first to cut its reliance on federal bailout programs.

About $245 billion of 90-day commercial paper that companies sold to the Federal Reserve starting in October will mature this week and next, central bank data show. As much as $50 billion to $70 billion of the debt may be rolled over and bought by investors, according to Barclays Capital in New York.

The market’s ability to absorb the maturing debt may build confidence that U.S. companies are able to fund themselves without government support, said Deborah Cunningham, chief investment officer for taxable money markets at Federated Investors Inc. Investors, betting the commercial paper market has stabilized, pushed interest rates to record lows this month and bought the most 90-day debt since September, Fed data show.

The debt rollover represents “a test of how well the market can sustain itself,” said Cunningham, who is buying commercial paper for Pittsburgh-based Federated, which oversees $288 billion in money-market assets. “And I think it will pass the test.”

Rates on AA ranked financial commercial paper due in 90 days fell to a record low of 0.28 percent on Jan. 8, or 21 basis points more than the U.S. borrowing rate, Fed data show. They have since jumped to 2.15 percent, or 201 basis points more than the government yield on 90-day Treasury bills, as investors prepared to absorb at least $486 billion of overall paper coming due this week, according to Fed data. The gap peaked at 374 basis points on Oct. 15. The Fed data also reflect sales to the CPFF.

Slowing Economy

The Fed demands 2.24 percent to own unsecured debt, including a one percentage point fee, under its Commercial Paper Funding Facility.

Companies use commercial paper, which typically matures in nine months or less, to fund everyday expenses such as payroll and rent. Their need for the financing may wane during the U.S. recession, which started in December 2007. The economy contracted at a 5.5 percent annual rate from October through December, the biggest drop since 1982, according to the median estimate in a Bloomberg News survey before Commerce Department figures due Jan. 30.

Markets Freeze

Businesses and consumers haven’t benefited as much as banks from the more than $8.5 trillion the government has committed to shoring up the financial system. The difference between yields on 30-year mortgages and 10-year Treasury notes is 2.5 percentage points, compared with an average of 1.7 points during the past two decades, data compiled by Freddie Mac and Bloomberg show. Spreads on investment-grade corporate bonds averaged a near- record 553 basis points as of yesterday, more than double the pre-crisis high of 272 basis points of 2002, according to Merrill Lynch & Co.’s U.S. Corporate Master index.

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

After Lehman Brothers Holdings Inc. filed for bankruptcy on Sept. 15, the broader commercial paper market froze. The next day, the flagship $62.6 billion money-market fund of Reserve Management Co. became only the second of its kind to break the buck, or fall below the $1-a-share price paid by investors, triggering a run that helped freeze global credit markets and drive up borrowing costs.

Returns on money-market funds have dropped 62 percent since then, according to the Crane 100 Money Fund Index, which tracks the average annualized yield of the top 100 money funds during the previous seven days.

Access to Credit

The commercial paper market slumped 20 percent over six weeks as money-market investors fled for safer assets such as Treasuries. Prime money-market funds’ holdings of first-tier paper, rated at least P-1 by Moody’s Investors Service and A-1 by Standard & Poor’s, fell by 33 percent from Sept. 9 to Oct. 7, according to iMoneyNet of Westborough, Massachusetts.

On Oct. 27, the Fed set up the CPFF, complementing a separate program for asset-backed debt that began in September. They were intended to ensure companies had access to short-term credit and to ease redemption concerns at money-market funds. The amount outstanding under the asset-backed program peaked at $152.1 billion on Oct. 1, before plunging to a low of $14.8 billion last week as redemption concerns subsided.

Money Markets

The Fed set up another program, the Money Market Investor Funding Facility, to provide liquidity to money-market investors. The facility, which buys commercial paper due in 90 days or less, hasn’t been used since it began operating on Nov. 24.

About $220 billion to $230 billion of 90-day commercial paper sold to the Fed above market rates in October through the CPFF matures this week, said Garret Sloan, a short-term debt analyst at Wachovia Corp. in Charlotte, North Carolina. That’s as much as 66 percent of the $350 billion in debt that the CPFF owns. The Fed has purchased about one-fifth of the commercial paper market through the CPFF.

More than half of the debt coming due may be refinanced in the market or allowed to mature, Cunningham said. While the Fed will probably extend its commercial paper program beyond April, the market won’t need the facility a year from now, she said today in an interview on Bloomberg Television.

The Fed bought $145.7 billion of the debt in the program’s first three days. GE Capital Corp., a unit of General Electric Co. of Fairfield, Connecticut, and New York-based credit-card issuer American Express Co. were among the first companies to sell commercial paper to the Fed, Bloomberg data show. GE Capital was the biggest borrower in the commercial paper market in 2008, according to October data from JPMorgan Chase & Co. GE said Jan. 23 it hasn’t used the CPFF since November.

Morgan Stanley

Also signing up to sell to the Fed were Morgan Stanley, the second-biggest U.S. securities firm before converting to a bank last year; Hewlett-Packard Co. of Palo Alto, California, the world’s largest personal-computer and printer maker; and four units of American International Group Inc., the insurer rescued by the U.S. in September. Morgan Stanley and AIG are based in New York. Companies aren’t required to disclose how much debt they’ve sold through the Fed facility.

AIG’s International Lease Finance Corp. unit, which signed up to sell $5.7 billion of commercial paper, on Jan. 21 was cut to A-2 by S&P, making it ineligible to issue into the CPFF.

A Morgan Stanley spokeswoman, Jennifer Sala, didn’t immediately provide comment. Spokespeople for American Express and AIG didn’t immediately return calls seeking comment.

Hewlett-Packard

Hewlett-Packard, which may sell as much $10.4 billion of commercial paper to the Fed, hadn’t used the CPFF as of Oct. 31, the company said in a Dec. 18 filing. Spokeswoman Michaella Goldner declined to comment.

“Given our strong ratings, we have had no problem accessing the CP markets, and the interest rates on commercial paper have been substantially more attractive than rates on long-term corporate bonds,” HP Chief Financial Officer Cathie Lesjak told analysts during a Nov. 24 conference call.

Fed purchases declined in the first two weeks of the year as investors picked up the slack, reducing government buying to $179 million. First-tier commercial paper assets in prime money-market funds increased 26 percent to $790.6 billion as of Jan. 13, iMoneyNet data show.

Purchases jumped last week to $15.7 billion, the most since November, as some companies remained unable to sell 90-day commercial paper to investors at rates below the cost of issuing to the Fed. Joseph Abate, a money-market analyst at Barclays in New York, said the increase signaled the market may need more government support than he had expected. Prime money fund commercial-paper assets fell 2.46 percent last week.

‘Burning its Credibility’

Sales of commercial paper due in more than 80 days jumped to $39 billion yesterday, including CPFF issuance, Fed data show. About $24 billion of that was backed by assets and $5.2 billion was issued by first-tier financial companies with AA ratings.

The Fed probably will have to extend the CPFF past its scheduled April 30 expiration to avoid “burning its credibility” if it pulls back and the market then collapses, said Adolfo Laurenti, a senior economist at Mesirow Financial Inc. in Chicago.

The “market consensus” is that the CPFF will continue past April, Sloan said in a telephone interview. “And I think this week is going to be a very big factor in whether that happens.”

Policy makers also may force companies to wean themselves from federal help by making it “increasingly expensive” to use the CPFF, said Louis Crandall, the chief economist at Jersey City, New Jersey-based Wrightson ICAP, a research unit of ICAP Plc, the world’s largest inter-dealer broker.

Refinancing at Maturity

The Fed demands 1.24 percent to own unsecured debt, plus a one percentage point fee. The rate for paper backed by assets was 3.24 percent.

At current yields, selling commercial paper to the Fed may cost a typical borrower almost three percentage points more than market rates, indicating most companies are able to find non- government buyers for their debt.

Companies may have been refinancing CPFF debt for the past few weeks to avoid being forced to handle all of it at maturity, Abate said. Issuance of commercial paper due in more than 80 days has accelerated, with sales to market investors totaling $62.4 billion in the week ended Jan. 14, the most in almost five months, Fed data show.

Assets in money-market funds reached a record high of $3.92 trillion on Jan. 14, according to the Investment Company Institute. Money market funds are sitting on this pile of cash with few alternatives, Abate said.

Financial Paper

Yields on AA ranked financial paper were 3.25 percent on Oct. 26, or 36 basis points more than the initial CPFF rate, including the unsecured credit surcharge, which is waived for financial borrowers that issue commercial paper with U.S. backing, at an extra 50 basis points. A basis point is 0.01 percentage point.

AA rated 90-day asset-backed commercial paper yielded a low of 0.28 percent on Jan. 9, or 290 basis points less than the CPFF charges to own the debt. Meanwhile, rates on second-tier 90-day commercial paper ranked one grade lower and excluded from the CPFF have plunged about five percentage points in the past month, to a five-year low of 1.16 percent on Jan. 20.

“At this point, if you have to issue into the CPFF, it is clearly punitive to the issuer relative to market levels,” Sloan said in an e-mail. “There will be some widening in spreads as the market tries to absorb the roll, but it shouldn’t climb back to CPFF funding levels.”

To contact the reporter on this story: Bryan Keogh in New York at bkeogh4@bloomberg.net

Last Updated: January 27, 2009 14:57 EST