As part of its response to the COVID-19 crisis, on March 23, 2020, the Board of Governors of the Federal Reserve System announced a number of new programs designed to limit credit market disruption. Two of these new programs put the Federal Reserve in an unprecedented role as a direct participant in the corporate debt capital markets.
Primary Market Corporate Credit Facility (PMCCF). First, the Federal Reserve has established a Primary Market Corporate Credit Facility (the “Primary Facility”). Under this facility, the Federal Reserve Bank of New York will lend to a special purpose vehicle (an “SPV”) on a recourse basis. The SPV will purchase qualifying bonds directly from eligible issuers, and will provide loans directly to eligible issuers.
To qualify to borrow under the Primary Facility, companies must be U.S. companies headquartered in the United States and with material operations in the United States. Companies expected to receive direct financial assistance under other economic legislation relief are not eligible. Companies eligible to receive loans or issue bonds under the Primary Facility must also have an investment grade rating (i.e., rated at least BBB-/Baa3 by one or more nationally recognized statistical rating organizations, or by at least two such rating agencies if they are rated by multiple rating agencies). The debt must have a maturity of four years or less.
Individual limits apply to each borrower, based on the borrower’s credit rating, as a percentage (ranging between 110% and 140%) of the amount of outstanding bonds or loans of the borrower on any day in the year preceding March 22, 2020. Interest rates will be “informed by market conditions” and may be payable in-kind (PIK) at the borrower’s election for the first 6 months to preserve cash. Borrowers who elect a PIK option may not pay dividends or make stock buybacks during the period it is not paying cash interest.
The Primary Facility will be making loans to eligible borrowers through September 30, 2020 unless it is extended by the Federal Reserve. BlackRock Financial Markets Advisory has been retained as the investment manager for the facility.
Secondary Market Corporate Credit Facility (SMCCF). Second, the Federal Reserve has established a Secondary Market Corporate Credit Facility (the “Secondary Facility”). Through this facility, the Federal Reserve Bank of New York will lend to an SPV on a recourse basis. This SPV will be used to purchase in the secondary market corporate debt issued by eligible issuers.
To be eligible for purchase under the Secondary Facility, corporate bonds must be issued by an eligible issuer, be investment grade, and have a remaining maturity of five years or less. Similar to the Primary Facility, eligible issuers are U.S. companies headquartered in the United States and with material operations in the United States, who are not expected to receive direct assistance through other relief legislation. The Secondary Facility may also purchase US-listed exchange traded funds (ETFs) whose investment objective is to provide broad exposure to the market for US investment grade corporate bonds.
The Secondary Facility will not purchase more than 10% of a corporate issuer’s maximum bonds outstanding on any day in the year prior to March 22, 2020, and will not purchase more than 20% of the assets of any single ETF as of March 22, 2020.
The Secondary Facility will make secondary market purchases through September 30, 2020, unless it is extended by the Federal Reserve. As with the Primary Facility, BlackRock Financial Markets Advisory has been retained as the investment manager for the facility.
Analysis. The Treasury Department has announced that the Primary Facility and the Secondary Facility, together with the Term Asset-Backed Securities Loan Facility (TALF) announced at the same time, are expected to provide up to $300 billion in new financing, with a total of $30 billion coming from equity provided under the Exchange Stabilization Fund and the balance in loans from the Federal Reserve that will be secured by the loans made or purchased by the applicable SPV. The size might be expected to increase if the COVID-19 virus continues to keep the US economy on virtual lock-down.
The direct lending program under the Primary Facility is an unprecedented effort by the federal government to provide quick liquidity directly to investment-grade corporate borrowers rather than facilitating access to capital through lending to banks, whose leverage and regulatory capital requirements may limit their ability to apply all of the funds to making loans. The program may prove useful to investment grade borrowers with refinancing or immediate funding needs, at least as an alternative borrowing source. It leaves non-investment grade borrowers, who may be even more pinched in a credit crunch, left to their bank lending relationships and other traditional sources of funding. (See this summary of issues facing middle market borrowers and their lenders.)
The purchases of existing bonds through the Secondary Facility may help stabilize liquidity conditions in a multi-trillion dollar financial market, which would presumably facilitate new lending by those who gain liquidity by selling their bonds.
The exact scope and efficacy of these programs has not yet come into focus. One consequence will surely be an increased emphasis on the densely populated border between investment and non-investment grade debt, with companies in the lower tier of investment grade ratings who are at risk of a downgrade into non-investment grade territory facing increased borrowing costs. Another is the precedent being set in bypassing the traditional intermediaries who evaluate and price credit risk, as the federal government becomes a direct lender and corporate bond investor.
Your regular Locke Lord contact and any of the authors would be happy to discuss any of these matters with you. Visit our COVID-19 Resource Center often for up-to-date information to help you stay informed of the legal issues related to COVID-19.
 Other steps announced at the same time include purchases by the Federal Open Market Committee of at least $500 billion of Treasury securities and $200 billion of mortgage backed securities, including agency commercial mortgage-backed securities; reintroduction of the 2008 financial crisis-era Term Asset-Backed Securities Loan Facility (TALF) to enable the issuance of securities backed by student loans, auto loans and other consumer credit and to encourage lending to small businesses and households; and expansion of support to the Money Market Mutual Fund Liquidity Facility.