April 9, 2020 will go down in the history of the Federal Reserve as a watershed day. The Fed came out with a plethora of lending programs that cover all manner of assets and asset classes the likes of which have never been employed before in the Fed’s storied history. In essence, the Fed is answering the need for liquidity (read cash) in all corners of the economy. Much like Elizabeth Warren’s campaign catchphrase, “we’ve got a plan for that,” so too does the Fed. Worried about funding your PPP loans? The Fed has a plan for that. Worried about your other business borrowers too big to utilize the SBA PPP program? The Fed has a plan for that. Worried about liquidity in car loans, credit card balances, and other consumer credits? The Fed has a plan for that. And finally, we’re all worried about the impact of the recession on state and local governments to continue providing services that we rely on. Well, the Fed has a plan for that too. In the section below we provide more details on the new programs but think of them as vehicles providing liquidity directly to economic areas never before attempted by the Fed. They are trying to prevent a liquidity crisis from becoming a solvency crisis and these programs should help do that.
The programs the Fed announced yesterday for the most part utilize a clever way to leverage seed money provided to the Treasury in the recently passed CARES Act. For many of the programs mentioned below the Treasury is providing equity to a Fed-controlled Special Purpose Vehicle (SPV) which will then buy various loans and securities, or lend funds secured by various loans and securities. The equity provided by the Treasury will generally be leveraged 10x, thus, with $230 billion in Treasury-supplied capital, the Fed can leverage up to $2.3 trillion in loan purchases and funding. Oh, and the Treasury has another $220 billion from the CARES Act which can be leveraged into $2.2 trillion of additional Fed assistance. Some highlights of the new programs below:
- First, the Fed wants to bolster the effectiveness of the SBA Paycheck Protection Program (PPP) by supplying liquidity to participating financial institutions through term financing backed by PPP loans to small businesses. The PPP Liquidity Facility (PPPLF) will extend credit to eligible financial institutions that originate PPP loans, taking the loans as collateral at face value. The rate will be 0.35% and will be 0% risk-weighted.
- The Fed wants to ensure credit flows to small and mid-sized businesses with the purchase of up to $600 billion in business loans that have less than 10,000 employees or $2.5 billion or less in revenue through the Main Street Lending Program. Principal and interest payments will be deferred for one year. Banks may originate new Main Street loans or use Main Street loans to increase the size of existing business loans. Banks will retain a 5% share, selling the remaining 95% at par to the Main Street facility. Firms seeking Main Street loans must commit to make reasonable efforts to maintain payroll and retain workers. Borrowers must also follow compensation, stock repurchase, and dividend restrictions that apply to direct loan programs under the CARES Act. Firms that have taken advantage of the PPP may also take out Main Street loans.
- The Fed wants to increase the flow of credit to households and businesses through capital markets, by expanding the size and scope of the Primary and Secondary Market Corporate Credit Facilities (PMCCF and SMCCF) as well as the Term Asset-Backed Securities Loan Facility (TALF). These three programs will now support up to $850 billion in Fed purchases ($500b PMCCF, $250b SMCCF, and $100b TALF). In addition, TALF-eligible collateral will now include triple-A rated tranches of both commercial MBS and newly issued collateralized loan obligations. The TALF will support the issuance and liquidity of asset-backed securities that fund a wide range of lending, including student loans, auto loans, and credit card loans.
- To support pricing in the PMCCF, the SMCCF will make secondary market purchases of individual corporate bonds as well as corporate bond ETFs. The preponderance of ETF holdings will be of ETFs whose primary investment objective is exposure to U.S. investment-grade corporate bonds, and the remainder will be in ETFs whose primary investment objective is exposure to U.S. high-yield corporate bonds. The issuers must have been rated at least BBB-/Baa3 as of March 22, 2020. An issuer that was subsequently downgraded, (so-called fallen angels) must be rated at least BB-/Ba3 when the Facility makes a purchase.
- State and local governments will be helped by the Municipal Liquidity Facility that will offer to buy short-term notes from states and municipalities that are expected to face cash flow pressures in the coming months. The facility will purchase up to $500 billion of short term notes (24 months or less in maturity) directly from U.S. states (including the District of Columbia), U.S. counties with a population of at least two million residents, and U.S. cities with a population of at least one million residents. Eligible state-level issuers may use the proceeds to support additional counties and cities. In addition to the actions described above, the Federal Reserve will continue to closely monitor conditions in the primary and secondary markets for municipal securities and will evaluate whether additional measures are needed to support the flow of credit and liquidity to state and local governments.
So, in one day the Fed has essentially said we will be there to support and facilitate the credit and liquidity function in this country across almost all economic agents. While the length of the bridge across the economic freeze is unknown, the Fed is providing a wide bridge that encompasses many sectors not ever before covered by Fed action. It’s a momentous move made in momentous times. The full details and term sheets on the various programs can be found here.
Muni Yields React to Fed’s Muni Program
When the Fed announced the Municipal Lending Facility yesterday it lifted some of the cloud over this sector of the market. Obviously the building recession will have a negative impact to the finances and liquidity to all states, counties and cities. The Fed’s announcement yesterday provides a liquidity bridge for the municipal sector until the coronavirus storm passes. That measure of relief is reflected in pricing in the muni market. The blue line in the graph represents yields at the beginning of April in the AAA-rated sector while the red line represents the current yield following the Fed’s announcement. For those carrying muni bonds it may be comforting to see that the Fed’s actions are already having an impact on prices with yields dropping by 21 to 46bps.
|Treasury Curve||Today||Chg Last Wk.||LIBOR Rates||Today||Chg Last Wk.||FF/Prime||Rate||Swap Rates||Rate|
|3 Month||0.19%||+0.12%||1 Mo LIBOR||0.82%||-0.20%||FF Target Rate||0.00%-0.25%||3 Year||0.458%|
|6 Month||0.22%||+0.09%||2 Mo LIBOR||1.31%||-0.13%||Prime Rate||3.25%||5 Year||0.563%|
|2 Year||0.23%||-0.01%||6 Mo LIBOR||1.23%||+0.03%||IOER||0.10%||10 Year||0.809%|
|10 Year||0.72%||+0.13%||12 Mo LIBOR||1.05%||+0.05%||SOFR||0.01%|