FED – assistance programs for the American economy

On April 9, 2020 in the morning local time, the Federal Reserve Board announced details of USD 2.3 trillion of loans and economic assistance programs, consisting of:

1.  Main Street Lending Program,
2. Paycheck Protection Program Lending Facility,
3. New Municipal Liquidity Facility,
4. Developing existing primary and secondary corporate bond purchase instruments (TALF, PMCCF, SMCCF).

FED loans and instruments are based on capital made available by Treasury under the CARES Act. Of the total $ 454 billion that Congress has earmarked for security for the FED, $ 195 billion will be used in the first stage, with the remaining funds available for other purposes or if necessary, to extend existing programs.

In the first stage, the funds are provided to the FED, so that it can provide „a leverage” appropriate for the program needs enabling the release of loans equivalent to ten times the funds deposited by the Government (this level of leverage provides that the capital losses on loans granted will not be higher than 10 %).

Source: RCieSolution Research

USD 454 billion deposited by Treasury, assuming a loss ratio of no more than 12%, the Federal Reserve Board (FRB) provides liquidity of approximately USD 8 x 454 billion, i.e. approximately USD 3.6 T, which in turn is delivered to investment grade companies in the form of loans. The total value of the FED loan facility will be determined by the amount of USD provided by the FED for each dollar deposited by the government (equity) and the investment rating of the borrowers (credit box).

Two hours after the announcement of program plans, Jerome Powell during the Brookings webinar said that if needed, the FED would respond by increasing available capital pools and expanding the territory of its operations. He described the loan programs as the main area of ongoing operations of the FED while maintaining the current monetary policy line.

Details of programs

1. Main Street Lending Program – USD 75 billion in equity capital, up to USD 600 billion in loan capacity

For small and medium enterprises, the program will consist of two programs shared by one special purpose vehicle (SPV):

The new loan facility (MSNLF-Main Street New Loan Facility) will grant four-year loans to enterprises employing up to 10,000 employees or up to USD 2.5 billion in annual revenues in 2019. Loans will be limited to a smaller amount: USD 25 million or 4x EBITDA in 2019, valued at SOFR + 250-400 bp, with an additional initial payment of 100 bp with deferred payment for one year. As expected, the loans will be granted through commercial banks, which will bear part of the risk associated with these loans, retaining a 5% share in the loan.

The expanded loan facility (MSELF-Main Street Expanded Loan Facility) will grant loans on the same terms as the new loan facility (MSNLF), but will grant loans in larger amounts. In particular, loans are limited to a smaller amount: USD 150 million, 30% of the borrower’s unused credit lines or 6 times EBITDA.
In both instruments, banks and borrowers must certify that the proceeds from the loan are not used to repay or refinance existing debt, except for mandatory capital repayments. Importantly, the restrictions set out in the CARES Act regarding management compensation, redemption and dividends apply to borrowers using these instruments.

2. Paycheck Protection Program Lending Facility – Equity capital USD 0 billion, unlimited loan possibilities

The program is to provide financing to banks participating in the PPP payout protection program. FED will grant loans without recourse against PPP loans as collateral in the amount of 35 bp. The loan will be granted for a period equal to the duration of the PPP loan, but the maturity will be shifted if the bank sells the PPP loan back to the Small Business Administration (SBA). Although the loans are 100% guaranteed by the Small Business Administration (SBA), this instrument should gradually help banks finance these loans. We also point out that regulators have eased the regulatory capital requirements for these loans by assigning them zero risk weight (the CARES Act requires it) and exempting them from calculating the leverage ratio.

3. New Municipal Liquidity Facility – USD 35 billion in equity capital, up to USD 500 billion in loan capacity

The loan institution will buy short-term bonds (maturity up to 24 months) directly from issuers at a price based on the assessment of the issuer’s creditworthiness at the time of purchase. The FED will limit the total purchases from one issuer to 20% of the issuer’s own revenues (as of the financial year 2017). Across the country, the figure was USD 2.4 trillion for the 2017 financial year, suggesting that the USD 500 billion foreseen will be sufficient to accommodate all potential loans if the 20% limit remains unchanged. Since almost all states and many local governments are struggling with balanced budgetary requirements for their overall operating budgets, the main goal of this instrument may be to help individual states cover short-term declines in income due to a decline in business as well as deferred taxation. The program does not close budgetary gaps in the state government, which requires Congressional fiscal aid of USD 100-200 billion.

4. Expansion of existing primary and secondary corporate bond purchase instruments (TALF, PMCCF, SMCCF) – USD 75 billion in equity capital, USD 750 billion in loan capacity

The FED increased its loan options and eased the conditions for corporate credit on the primary market (PMCCF) and corporate credit on the secondary market (SMCCF). The Treasury Department has allocated additional capital that will increase the available PMCCF capital to USD 50 billion and SMCCF capital to USD 25 billion, which in turn will allow 10 to 1 lending for the purchase of bonds or lending to investment grade entities and from 7 to 1 up to 3 to 1 for other assets (below the investment rating).

PMCCF (Primary Market Corporate Credit Facility) will now be able to buy corporate bonds with maturity up to 4 years, both as the only investor in the issue of bonds and as part of the syndication process, similar to the ECB. The FED has eased the conditions for issuers’ qualification by including those with a rating of at least BBB- / Baa3 (investment rating) as at March 22 (March 25, Ford has been deprived of its investment rating), including in the program issuers with a downgraded rating below investment (to BB- / Ba3 level or higher) at the time of purchase by FED (fallen angels). Issuers must be US companies, cannot be banks and can not be recipients of other specific support under the CARES Act.

SMCCF (Secondary Market Corporate Credit Facility) will purchase both individual corporate bonds with a remaining maturity of up to 5 years and corporate bond ETFs. The issuer’s eligibility criteria are the same as the criteria for the PMCCF. Most of the ETFs covered are exposed to investment grade bonds, but some of them are also exposed to high yield bonds. These are respectively 10 ETFs with exposure to investment rating (LQD, VCIT, VCSH, IGSB, MINT, JPST, IGIB, FLOT, SPSB, SPIB) – AUM in total about USD 152 billion and 10 ETF with exposure to HY bonds (HYG, JNK , USHY, SHYG, HYLB, SJNK, ANGL, HYLS, HYS, BSJL) – AUM in total about USD 43 billion. The program limit for the purchase of bonds and ETFs is: 10% of the issuer’s debt and 20% of the assets of ETF respectively, a new comprehensive issuer limit was added: 1.5% of the total potential size of primary and secondary market instruments, which corresponds to USD 11.25 billion.

Term Asset-Backed Securities Loan Facility ($10bn in capital, $100bn in capacity). The structure of the TALF program is very similar to what the Fed announced on March 23, but the eligible collateral has expanded to include AAA CLOs and AAA CMBS.

By implementing individual program options, the FED from the role of lender of last resort for banks effectively evolves towards a commercial bank of last resort for American economy. The FED explained that, acting in consultation with the Government, if it considers that companies differ significantly in terms of financial needs and with the implementation of the program, as a result of information collected from lenders, borrowers and other interested parties, if necessary it will intervene to support the economy so effectively and efficiently as possible while protecting taxpayers’ funds.

 The views expressed in this document do not constitute research, are not investment or commercial advice and do not necessarily reflect the views of all management teams. They change over time.