The Fed as lender of last resort
On April 9, the Federal Reserve announced that the US Treasury was increasing from USD20 bn to USD75 bn its equity funding for the central bank’s two new special purpose vehicles, the Primary Market Corporate Credit Facility (PMCCF) and Secondary Market Corporate Credit Facility (SMCCF). Using a leverage ratio of 10 to 1, this means the Fed has about USD750 bn available to buy corporate bonds. Interestingly, more of the Treasury funding has been allocated to the PMCCF (USD50 bn, giving the Fed fire power of USD500 bn) than to the SMCCF (USD25 bn).
As a reminder, the PMCCF aims to buy into new corporate bond issues, either as sole investor or as part of a syndicate. The SMCCF focuses on corporate bonds on the secondary market, as well as US-listed exchange traded funds (ETFs) invested primarily in US corporate bonds. Purchases are skewed towards investment grade (IG) names, but also include US high-yield (HY) ETFs.
Overall, through these two facilities, the Fed is showing its readiness to act decisively to ensure the smooth functioning of the corporate bond market, helping companies to fulfil their funding needs. The expansion of bonds eligible for Fed purchases to include recent fallen angels (under strict conditions), will enable companies that have recently lost their investment-grade rating to access funding more easily.
However, we believe the Fed remains focused on calming liquidity concerns rather than on corporate solvency issues. Only investment-grade companies or companies that have lost their IG rating since March 22 (‘fallen angels’), but still have a minimum rating of BB-, will be considered. In other words, is not buying all HY bonds outright, only a small amount of them through US HY exchange-traded funds (ETFs). Accordingly, US HY paper rated CCC and lower have not participated as much as their higher-rated counterparts in the recent corporate bond rally and quality continues to outperform in US credit year to date.
Our projections suggest the Fed will buy ‘only’ 17% of the eligible IG universe with a maturity up five years in the US and could end up owning only 3% of the US IG market across all maturities and 1% of the US HY one (including recent fallen angels). By way of comparison, the ECB could account for 15% of the euro IG market.
Market participants may consider the inclusion of fallen angels and of US HY ETFs as a sign that the Fed stands ready to contemplate outright purchases of HY bonds, but we still see this as unlikely. Moreover, the greater size of the primary facility along with the requirement for companies to actively certify their eligibility suggest the Fed is reluctant to become an active and important player in the US corporate bond market. This is different from the ECB, which will likely end up owning a more significant share of the euro investment-grade (IG) universe by year’s end after having increased the pace of its purchases.