On March 23, the Board of Governors of the Federal Reserve System (the “FRB”) announced the latest in a series of extraordinary actions intended to help mitigate the impacts of the COVID-19 pandemic on the U.S. economy. Unlike the measures announced last week – which mostly involved re-establishing emergency programs that were used during the 2008–09 financial crisis to help financial institutions – yesterday’s measures include several unprecedented actions designed to provide assistance to U.S. commercial enterprises.
A summary of all of yesterday’s FRB announcements is below.
Monetary Policy Changes
The Federal Open Market Committee announced that it would include purchases of agency commercial mortgage-backed securities in its previously announced purchase of at least $200 billion of agency mortgage-backed securities and at least $500 billion of U.S. Treasury securities, as necessary to maintain the federal funds rate in a target range of 0 to 1/4 percent.
Changes to Previously Announced Credit Facilities
The FRB expanded the scope of two credit facilities announced last week, as follows:
- Money Market Mutual Fund Liquidity Facility (“MMLF”): As we reported last week, the FRB reestablished the crisis-era MMLF to provide liquidity support to money market mutual funds by facilitating their sale of certain assets in order to meet redemption requests. The initial list of eligible collateral was already more expansive than the 2008–09 version of the program, and was expanded late last week to include U.S. municipal short term debt. Yesterday’s announcement again expands the list of eligible collateral, this time to include municipal variable rate demand notes and negotiable certificates of deposit. Yesterday’s announcement also provides that the facility will open on March 23, but negotiable certificates of deposit and variable rate demand notes may not be pledged until March 25.
To be eligible collateral, a negotiable certificate of deposit must meet the same rating and other eligibility requirements applicable to commercial paper. Variable rate demand notes must (i) have a demand feature that allows holders to tender the note at their option within 12 months, and (ii) must be rated in the top short-term or long-term rating category, as applicable, by at least two major rating agencies (or be rated as such by one agency if the note is only rated by one rating agency). The interest rate for advances secured by variable rate demand notes will be the same as for advances secured by U.S. municipal short-term debt (i.e., the primary credit rate plus 25 basis points); the interest rate for advances secured by negotiable certificates of deposit will be the primary credit rate plus 100 basis points.
The most recent version of the MMLF term sheet is available here; a comparison against the previous version is available here.
- Commercial Paper Funding Facility (“CPFF”): Similarly, as we reported last week, the FRB reactivated the crisis-era CPFF to provide liquidity to U.S. commercial paper issuers. The FRB announced yesterday that the list of eligible collateral will now include high-quality, tax-exempt commercial paper, in order to facilitate the flow of credit to municipalities.
The amended CPFF program terms and conditions also provide that issuers whose A1/P1/F1 rating was downgraded after March 17, 2020 will be able to make a one-time sale of A2/P2/F2 commercial paper to the facility, subject to Federal Reserve review. Pricing for such sales will be based on the three-month overnight index swap rate plus 200 basis points (compared to the overnight index swap rate plus 110 basis points for A1/P1/F1 commercial paper).
The most recent version of the CPFF term sheet is available here; a comparison against the previous version is available here.
New Credit Facilities
The Federal Reserve announced the establishment of three new special facilities designed to support credit to large employers as well as consumers and businesses. The facilities are authorized under section 13(3) of the Federal Reserve Act. Using the Exchange Stabilization Fund, the Department of the Treasury will provide $10 billion in equity to each of three new facilities.
- Primary Corporate Credit Facility (“PCCF”): As described in the PCCF term sheet, the new facility will serve as a funding backstop for investment-grade U.S. corporate debt issuers by purchasing qualifying bonds from eligible issuers and providing eligible loans to such issuers. Eligible issuers must be U.S.-headquartered companies with material U.S. operations. Eligible corporate bonds must have a maturity of four years or less and be rated at least BBB-/Baa3 by at least two major rating agencies (or be rated as such by one agency if the bond is only rated by one rating agency).
The maximum amount of outstanding bonds or loans of an eligible issuer may not exceed 110 to 140 percent of the issuer’s maximum outstanding bonds and loans on any day between March 22, 2019 and March 22, 2020, with the applicable percentage varying based upon the issuer’s rating. Interest rates for loans extended under the facility will be “informed by market conditions,” but issuers may elect to pay interest in kind for 6 months (extendable at the discretion of the FRB). If such an election is made, the issuer may not pay dividends or make stock buybacks during this period.
The term sheet indicates that the PCCF will cease purchasing eligible bonds or extending loans on September 30, 2020, unless the program is extended by the FRB.
- Secondary Market Corporate Credit Facility (“SMCCF”): As described in the SMCCF term sheet, the new facility will purchase eligible corporate bonds and eligible corporate bond portfolios in the form of exchange traded funds (“ETFs”) in the secondary market. Eligible corporate bonds must have a remaining maturity of five years or less, must be rated at least BBB-/Baa3 by at least two major rating agencies (or be rated as such by one agency if the bond is only rated by one rating agency), and must be issued by eligible issuers – U.S. issuers with material U.S. operations, who are not expected to receive direct financial assistance under pending federal legislation. Eligible ETFs must be U.S.-listed ETFs whose investment objective is to provide broad exposure to the market for investment-grade U.S. corporate bonds.
The facility will purchase eligible bonds and ETFs at fair market value in the secondary market. The maximum amount of individual corporate bonds that the facility may purchase is capped at 10 percent of the issuer’s maximum bonds outstanding on any day between March 22, 2019 and March 22, 2020; the facility will not purchase more than 20 percent of the assets of any particular ETF as of March 22, 2020.
The term sheet indicates that the SMCCF will cease purchasing eligible bonds and ETFs on September 30, 2020, unless the program is extended by the FRB.
- Term Asset-Backed Securities Loan Facility (“TALF”): The FRB will re-establish the crisis-era TALF, which made over $200 billion in non-recourse loans to holders of asset-backed securities between March 2009 and June 30, 2010.
As described in yesterday’s TALF term sheet, the new facility will serve as a funding backstop to facilitate the issuance of asset-backed securities (“ABS”) by making non-recourse loans to eligible borrowers with a term of three years that are fully secured by eligible ABS. Eligible borrowers must be companies formed under U.S. law or U.S. branches or agencies of foreign banks that own eligible collateral and that maintain an account relationship with a primary dealer.
Eligible collateral must be USD-denominated cash (i.e., non-synthetic) ABS issued on or after March 23, 2020 that have a credit rating in the highest long-term or short-term (as applicable) rating category from at least two major rating agencies, and do not have a credit rating below the highest investment-grade rating category from any major rating agency. Substantially all of the credit exposures underlying the ABS must have been originated by a U.S. company, and the underlying credit exposures must be one of enumerated categories (i.e., auto loans/leases, student loans, commercial/consumer credit card receivables, equipment loans, floorplan loans, insurance premium finance loans, SBA-guaranteed small business loans, certain servicing advance receivables).
Certain features will disqualify ABS from being eligible collateral. Eligible collateral will be valued and assigned a haircut according to a forthcoming schedule based sector, historical volatility, and other factors, in line with the schedule used for the TALF in 2008. Loans made under the facility will have an interest rate equal to 100 basis points over the 2-year or 3-year LIBOR swap rate depending on the weighted average life, but a different interest rate will apply to eligible ABS where the underlying credit exposures have a government guarantee. An administrative fee equal to 10 basis points of the loan amount will be assessed.
The term sheet indicates that the TALF will not make new credit extensions after September 30, 2020, unless the program is extended by the FRB. Further terms and conditions will be released in the coming days, and will be based off the 2008 TALF program.
Coming Soon: Main Street Business Lending Program
Yesterday’s announcement also indicates that the FRB will soon announce the establishment of a Main Street Business Lending Program to support lending to eligible small- and medium-sized businesses. The program will complement ongoing efforts by the Small Business Administration to help small businesses weather the economic conditions created by COVID-19.
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Covington & Burling LLP’s Financial Services attorneys have deep experience guiding U.S. and non-U.S. financial institutions through the most challenging circumstances, including the 2008–09 financial crisis. Our team, which includes former senior federal regulators, stands ready to advise financial institutions as they navigate the impact of COVID-19 on the economy and the financial markets.
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