Fed Actions May Stabilize Global Corporate Markets
Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, the US Federal Reserve has expanded support for corporate bonds. This is good news for companies that were financially solvent until the coronavirus crisis led to funding woes. We also see it as good news for global credit markets, as significant new supports could effect a regime shift in volatility.
On April 9, the Fed shared details around this support. Up to US$1.35 trillion—more than half of the funds provided under the CARES Act—will be available to support corporations through expanded corporate purchase facilities and the Main Street Lending Program (MSLP).
Specifically, the Fed will expand its Primary Market Corporate Credit Facility (PMCCF) and Secondary Market Corporate Credit Facility (SMCCF) to a total of US$750 billion in purchases, backed by US$85 billion from the US Treasury. The Fed will use the MSLP to buy up to $600 billion in small and midsize business loans outright, using $75 billion from the US Treasury.
Within the corporate purchase programs, the Fed has made some fallen angels—corporate debt downgraded from investment grade to below investment grade—eligible for purchase. These credits must have been rated investment grade as of March 22 but since been downgraded to BB. The central bank will also purchase high-yield ETFs as part of their ETF purchase program.
These actions are another demonstration of the Fed’s willingness to do whatever is necessary to keep the financial system functioning so the economy can restart quickly after the public health crisis has eased.
A Critical Liquidity Backstop for US Corporate Markets
Each of the three corporate-related programs has major implications for the US corporate markets.
First, the SMCCF’s inclusion of fallen angels and high-yield ETFs as eligible purchases should help stabilize markets. The potential for a blizzard of fallen angels to overwhelm the high-yield market in terms of both comparative volume and difference in average market duration (interest-rate sensitivity) has exerted enormous pressure on both bonds rated BBB– and the highest-rated high-yield bonds. With the Fed prepared to buy certain fallen angel debt, that pressure will be reduced.
Second, the PMCCF reduces the risk that fallen angels might not be able to access the capital markets. Through this facility, companies can now meet their refinancing needs within the three months prior to a maturity. The PMCCF also provides fallen angels with liquidity during the crisis. Companies may borrow up to 130% of long-term maturity borrowings, as long as ratings for the incremental debt are affirmed at low BB or better.
Third, the MSLP could be a potential source of capital for high-yield and leveraged-loan issuers. Under the program, the Fed can provide up to US$600 billion of loans for US companies with fewer than 10,000 employees or US$2.5 billion in 2019 revenue.