Federal Reserve Issues New Lending Facilities
Our previous communication regarding the fiscal package recently passed into law mentions the large number of programs contained in this massive package. One item included in the package is $454 billion in approved funding to backstop the Federal Reserve’s new lending facilities. The Federal Reserve is taking unprecedented steps to prevent a liquidity crisis resulting from the economic effects of the pandemic. We would like to provide you with a short summary of these new lending facilities created on March 23rd to support smooth market functioning.
You might recall the term Quantitative Easing (QE), which was used to describe a monetary policy tool used during the financial crisis of 2008-2009. QE refers to when the Federal Reserve purchased U.S. Treasuries, U.S. Government Agency Bonds and U.S. Government Agency Mortgage-Backed Securities (MBS) and held these securities on their balance sheet. One of the seven new facilities opened recently includes the unlimited purchase of U.S. Treasuries and Agency MBS to support these markets. In the past, specific dollar amounts had been targeted whereas this facility is open ended until September 30, 2020. The Fed is stepping in as a buyer to provide liquidity for the vast amount of selling in these securities in recent weeks. This facility has already accomplished much of what it was intended to do by stabilizing liquidity in the Treasury market and bringing spreads on MBS back down to the level at the start of the year.
In addition to unlimited Treasury and MBS purchases, the following new facilities have been created:
Money Market Mutual Fund Liquidity Facility
The Money Market Mutual Fund Liquidity Facility provides $10 billion in funding from the Treasury to the Fed. The Fed will lend to banks so that banks can purchase money market assets from money market funds that are trying to sell to meet redemptions. Eligible collateral for pledging against the loans include commercial paper, U.S. Treasuries and Agency Bonds, and short term U.S. municipal debt maturing within one year.
Commercial Paper Funding Facility
The Commercial Paper Funding Facility is a credit facility to a Special Purpose Vehicle (SPV) that will serve as a funding backstop to facilitate the issuance of commercial paper (unsecured, short-term debt issued by corporations). The Treasury has committed a $10 billion equity investment in the SPV. Highly rated U.S. issuers of commercial paper can qualify for this lending facility. The SPV will cease purchasing commercial paper on March 17, 2021 unless the Federal Reserve Board extends this facility.
Primary Dealer Credit Facility
The Primary Dealer Credit Facility provides loans to primary dealers in exchange for a broad range of collateral (including equity securities) for funding with maturities up to 90 days. This line is intended to support the credit needs of households and businesses by expanding the ability of primary dealers to gain access to term funding. Primary dealers are banks and other financial institutions that buy government securities directly from the government with the intention of reselling them to other buyers. In contrast to similar facilities available in 2008, this facility will provide term loans (up to 90 days) versus only overnight loans during the financial crisis. This facility will remain in place to primary dealers for at least six months, or longer if conditions warrant.
Primary Market Corporate Credit Facility
The Primary Market Corporate Credit Facility will use an SPV with $100 billion authorized to purchase corporate bonds from eligible issuers and provide loans to eligible issuers (U.S. companies headquartered in the U.S. and with material operations here). Bonds and loans must be investment grade with 4 years or less maturity at time of purchase. Eligible issuers do not include companies that are expected to receive direct financial assistance under the fiscal package.
Secondary Market Corporate Credit Facility
The Secondary Market Corporate Credit Facility will serve as a secondary market backstop for corporate bonds already issued. An SPV with a $100 billion authorized will purchase qualified investment grade corporate bonds with a maturity of 5 years or less at the time of purchase and purchase shares in corporate bond exchange traded funds (ETFs) to support this market. This facility will purchase eligible corporate bonds at fair market value in the secondary market and will not purchase more than 20% of the assets of any particular ETF. The facility will avoid purchasing shares of eligible ETFs when they trade at prices that materially exceed the estimated net asset value of the underlying portfolio.
Term Asset-Backed Securities Loan Facility
The Term Asset-Backed Securities Loan Facility was authorized to help meet the credit needs of consumers and small businesses by facilitating the issuance of asset-backed securities (ABS) and improving market conditions for ABS. The SPV initially will make up to $100 billion of loans available to eligible borrowers, with all loan terms of three years or less. Eligible borrowers are all U.S. companies that own eligible collateral and maintain an account relationship with a primary dealer. Eligible collateral includes ABS where the underlying credit exposures are one of the following: auto loans and leases, student loans, credit card receivables, equipment loans, auto floor plan loans, insurance premium finance loans, and small business loans guaranteed by the Small Business Administration. To be eligible, all or substantially all of the underlying credit exposures must be newly issued.
As you might be aware, the funding source for many of the consumer loans mentioned above is created when financial institutions pool a large number of similar loans together and securitize these “pools” into a marketable security that can be traded. The Term Asset-Backed Securities Loan Facility will be an important resource to enable lenders to continue to provide this type of consumer lending.
As mentioned previously, some of these lending facilities (or similar facilities) had been available during the financial crisis of 2008-2009. A majority of the intellectual and legal work had already been done to facilitate the creation of these instruments, thereby allowing the Federal Reserve and the Treasury to act quickly this time to ease liquidity pressures.
As a result of these lending facilities, the Fed’s current balance sheet of $4.7 trillion in assets is expected to rise to $9 trillion by some estimates, or 40% of last year’s GDP. While that level might sound alarming, in comparison the Bank of Japan’s balance sheet equals 105% of GDP. As this global health crisis continues to impact the economy, the Federal Reserve stands ready to meet the liquidity needs of markets and financial institutions. Ensuring the smooth functioning of fixed income markets is critical to our financial system and evidence thus far has shown these efforts to be successful. As monetary policy continues to evolve in this unprecedented environment, we will continue to keep you updated.
Please reach out to your advisor at Smith & Howard Wealth Management with any questions or comments. We appreciate your continued confidence.