Heisenberg Report

Buy America! Fed Launches Primary Corporate Credit Facility

If the buying of credit ETFs and corporate bonds through the Fed’s secondary market facility offended your sensibilities, I suppose you can feign even greater levels of incredulity on Monday.

To kick off the holiday-shortened week, the Fed said the primary market corporate facility is now operational. These would be direct purchases from eligible issuers who meet the conditions for the program.

For anyone who needs a refresher on that, here are the boxes you need to check if you want to sell to the Fed:

  1. The issuer is a business that is created or organized in the United States or under the laws of the United States with significant operations in and a majority of its employees based in the United States.
  2. The issuer was rated at least BBB-/Baa3 as of March 22, 2020, by a major nationally recognized statistical rating organization (“NRSRO”). If rated by multiple major NRSROs, the issuer must be rated at least BBB-/Baa3 by two or more NRSROs as of March 22, 2020.
    • An issuer that was rated at least BBB-/Baa3 as of March 22, 2020, but was subsequently downgraded, must be rated at least BB-/Ba3 as of the date on which the Facility makes a purchase. If rated by multiple major NRSROs, such an issuer must be rated at least BB-/Ba3 by two or more NRSROs as of the date on which the Facility makes a purchase.
    • In every case, issuer ratings are subject to review by the Federal Reserve.
  3. The issuer is not an insured depository institution, depository institution holding company, or subsidiary of a depository institution holding company, as such terms are defined in the Dodd-Frank Act.
  4. The issuer has not received specific support pursuant to the CARES Act or any subsequent federal legislation.
  5. The issuer must satisfy the conflicts-of-interest requirements of section 4019 of the CARES Act

If you can say that you meet all of those requirements, congratulations! You are now backstopped by Jerome Powell. And also by Steve Mnuchin and his $50 billion, taxpayer-sponsored capital buffer.

Admittedly, I’m employing language designed to rile the audience. Regular readers know I’m not particularly keen on the notion that the Fed’s corporate bond-buying programs are actually as offensive as many people seem to believe they are.

Other developed market central banks have been buying corporate bonds for years, and besides, when the Fed engineers a hunt for yield (by sequestering Treasurys and driving rates into the floor), the whole purpose is to push investors out of risk-free assets and into things like corporate bonds, which in turn pushes down borrowing costs. This is just the logical (or illogical, depending on how you’re inclined to view things) next step.

“The Facility may purchase eligible corporate bonds as the sole investor in a bond issuance” or participate in syndicated deals, the Fed said, adding the following details:

Issuers may approach the Facility to refinance outstanding debt, from the period of three months ahead of the maturity date of such outstanding debt. Issuers may additionally approach the Facility at any time to issue additional debt, provided their rating is reaffirmed at BB-/Ba3 or above with the additional debt by each major NRSRO with a rating of the issuer. The maximum amount of outstanding bonds or loans of an eligible issuer that borrows from the Facility may not exceed 130 percent of the issuer’s maximum outstanding bonds and loans on any day between March 22, 2019, and March 22, 2020.

Over the weekend, the Fed revealed the composition of its individual corporate bond portfolio accumulated so far through the secondary facility. The central bank also unveiled the index it’s using to make the purchases.

The full story is in the linked post below, but for those who missed it, the table shows what the Fed’s portfolio looked like after the first day or two of buying earlier this month.

The market celebrated on June 15 when the Fed announced it was moving forward with the purchase of individual corporate bonds in addition to credit ETFs.

It’s not yet clear whether we’ll see the same follow-through “announcement effect” tied to the official rollout of the primary facility. It’s probably worth watching at the individual issuer level to see how the assets of borrowers at the weak end of the eligible spectrum behave.

There are myriad tired, old jokes I could roll out, but I’ll refrain in favor of flatly stating the obvious. Even if you’re like me and see the utility in these programs, the inescapable reality is that the US corporate bond market will be seen going forward as carrying at least some form of government guarantee, especially during times of crisis.

For three months following the unveil of the central bank’s two facilities (in late March), the market gleefully looked to frontrun Jerome Powell. Inflows into investment grade and high yield bond funds approximated a tsunami, while both blue-chip and junk borrowers set records in the primary market (see the latter two linked posts below).

Theoretically, the less use the primary facility sees the better. After all, if the Fed is buying directly, it presumably means there was a need to do so, beyond simply proving their commitment to following through. It’s possible there could be a stigma attached to borrowers in the primary facility, but that’s something the Fed would look to mitigate.

Read more:

Fed Unveils Composition Of Corporate Bond Portfolio. Why Not Have A Look?

Congrats To Jay Powell! June Junk Bond Bonanza Shatters All-Time Record

The US Corporate Bond Market Just Keeps Smashing Records