In the face of the coronavirus (COVID-19) pandemic, the U.S. Federal Reserve Board (the Fed) and the U.S. federal banking agencies have announced several market and supervisory actions to address the sudden market stress and strain.
The Fed is the central bank of the United States and a banking regulator, and it is taking a series of actions similar to some of those taken during the 2007–2008 financial crisis. The Office of the Comptroller of the Currency (the OCC) and the Federal Deposit Insurance Corporation (the FDIC) are the other U.S. federal banking regulators. The actions described below are aimed to assist banks, businesses and consumers, all of whom face unique challenges because of the sudden closure of businesses and market volatility. In doing so, the Fed is drawing upon its authority under Section 13(3) of the Federal Reserve Act. As distinct from the last financial crisis, however, these actions appear to be in reaction to shut downs in the real economy and the need for credit to be extended to a range of borrowers, rather than a perceived seizing up of the liquidity and credit of the financial institutions themselves.
We will continue to monitor legislative, supervisory and market actions taken by bank regulatory agencies as events unfold. Given the market developments since the impact of the pandemic has been absorbed, we anticipate regular developments in this space, and will regularly update this note.
(Updated) FOMC Operations
The Federal Open Market Committee (FOMC) announced on March 23 an expansion of its program to purchase Treasury securities and agency mortgage-backed securities (MBS), stating it would continue to purchase such assets "as necessary." The Open Market Trading Desk indicated that it plans to conduct operations totaling approximately $75 billion of Treasury securities and approximately $50 billion of agency MBS each business day during the week of March 23. The Fed had previously announced it would purchase at least $500 billion of Treasury securities and at least $200 billion of MBS. In addition, the Fed announced it would include agency commercial MBS in its agency MBS purchases.
The Open Market Desk will also conduct overnight reverse repurchase operations, along with reverse repurchase operations with maturities of more than one day when necessary to accommodate weekend, holiday, or similar trading conventions, at an interest rate of 0 percent. Such reverse repurchase transaction amounts will be limited only by the value of Treasury securities held outright in the System Open Market Account that are available for such operations and by a per-counterparty limit of $30 billion per day.
In addition, the Open Market Desk will continue rolling over at auction all principal payments from the Fed's holdings of Treasury securities and to reinvest all principal payments from its holdings of agency debt and agency MBS received during each calendar month in agency MBS. Lastly, the Open Market Desk will engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the Fed's agency MBS transactions.
(Updated) The Fed Announces Three Additional Loan Facilities
The Fed announced on March 23 the establishment of three additional loan facilities: (i) the Primary Market Corporate Credit Facility (PMCCF); (ii) the Secondary Market Corporate Credit Facility (SMCCF); and (iii) the Term Asset-Backed Securities Loan Facility (TALF).
Under each of the PMCCF, SMCCF and TALF, Treasury will make an initial $10 billion equity investment in each Facility's SPV using the Exchange Stabilization Fund (ESF).
The Fed's Primary Market Corporate Credit Facility (PMCCF)
The Fed established the PMCCF in order to serve as a funding backstop for corporate debt issued by eligible issuers. Under the PMCCF, the Federal Reserve Bank of New York (FRBNY) will commit to lend to a special purpose vehicle (SPV) on a recourse basis. The SPV will purchase qualifying bonds directly from and provide loans to eligible issuers. The FRBNY loan will be secured by all the assets of the SPV.
- An "eligible issuer" under the PMCCF is a U.S. company headquartered in the United States and with material operations in the United States. An eligible issuer does not include a company that is expected to receive direct financial assistance under pending federal legislation.
- "Eligible assets" under the PMCCF are corporate bonds that, at the time of the bond purchase or loan origination by the PMCCF are issued by an eligible issuer, rated at least BBB-/Baa3, and have a maturity of four years or less.
- The borrower may elect for all or a portion of the interest due and payable on each interest payment date to be payable in kind for 6 months, extendable at the discretion of the Fed. Such interest amount will be added to, and made part of, the outstanding principal amount of the bond or loan. A borrower that makes this election may not pay dividends or make stock buybacks during the period it is not paying interest. In addition, bonds and loans under the PMCCF are callable by the eligible issuer at any time at par.
- The PMCCF will cease purchasing eligible corporate bonds or extending loans on September 30, 2020, unless extended by the Fed. In addition, the FRBNY will continue to fund the PMCCF after September 30 until its underlying assets mature.
The Fed's Secondary Market Corporate Credit Facility (SMCCF)
Under the SMCCF, the FRBNY will lend, on a recourse basis, to an SPV that will purchase in the secondary market corporate debt issued by eligible issuers. The SPV, for its part, will purchase eligible individual corporate bonds as well as eligible corporate bond portfolios in the form of exchange-traded funds (ETFs) in the secondary market. The FRBNY loan will be secured by all the assets of the SPV.
- An "eligible issuer" for individual corporate bonds is a U.S. business with material operations in the United States. An eligible issuer does not include a company that is expected to receive direct financial assistance under pending federal legislation.
- An "eligible individual corporate bond" under the SMCCF is a corporate bond that, at the time of the bond purchase by the SMCCF, is issued by an eligible issuer, is rated at least BBB-/Baa3, and has a remaining maturity of five years or less.
- An "eligible ETF" is a U.S.-listed ETF whose investment objective is to provide broad exposure to the market for U.S. investment grade corporate bonds. The SMCCF will avoid purchasing shares of eligible ETFs when they trade at prices that materially exceed the estimated net asset value of the underlying portfolio.
- The SMCCF will purchase eligible corporate bonds at fair market value in the secondary market.
- The SMCCF will cease purchasing eligible corporate bonds and eligible ETFs no later than September 30, 2020, unless extended by the Fed. However, the FRBNY will continue to fund the SMCCF after such date until the SMCCF's holdings either mature or are sold.
The Fed's Term Asset-Backed Securities Loan Facility (TALF)
The TALF was established to facilitate the issuance of asset-backed securities (ABS) and improve the market conditions for ABS more generally. Under the TALF, the FRBNY will lend to an SPV on a recourse basis.
- The Department of the Treasury will make an equity investment of $10 billion in the SPV in connection with the TALF. Initially, the TALF SPV will make up to $100 billion of nonrecourse loans available with three-year terms. Such loans will be fully secured by eligible ABS.
- Under the TALF, an "eligible borrower" is a U.S. company that owns eligible collateral and maintains an account relationship with a primary dealer. A U.S. company is a U.S. business entity organized under the laws of the United States or a political subdivision or territory thereof (including an entity that has a non-U.S. parent company), or a U.S. branch or agency of a foreign bank.
- "Eligible collateral" includes newly issued (on or
after March 23) U.S. dollar denominated cash ABS, that have a
credit rating in the highest long-term or the highest short-term
investment-grade rating category and do not have a credit rating
below the highest investment-grade rating category. In addition,
all or substantially all of the credit exposures underlying
eligible ABS must have been originated by a U.S. company and not
bear interest payments that step up or step down to predetermined
levels on specific dates. The underlying credit exposures of such
ABS may not be include exposures that are themselves cash ABS or
synthetic ABS and must be one of the following:
- Auto loans and leases;
- Student loans;
- Consumer or corporate credit card receivables;
- Equipment loans;
- Floorplan loans;
- Insurance premium finance loans;
- Certain small business loans that are guaranteed by the Small Business Administration; or
- Eligible servicing advance receivables.
- A borrower under the TALF may, at its option, pre-pay its loan, in whole or in part, but the TALF does not permit substitution of collateral during the term of the loan.
- Unless extended by the Fed, the TALF will not issue new credit after September 30, 2020.
(Updated) The Fed's Money Market Mutual Fund Liquidity Facility
The Fed announced on March 18 the establishment of a Money Market Mutual Fund Liquidity Facility (MMMLF), which was followed by publication of an interim final rule on March 19 and the expansion of the facility on March 20. On March 21, the Fed published MMMLF FAQs (the FAQs) to clarify the scope and procedures of the MMMLF.
- Money Market Mutual Funds. Under the MMMLF, the Federal Reserve Bank of Boston (Boston Fed) will make loans available to eligible financial institutions secured by high-quality assets purchased by the financial institution from a Prime, Single State or Other Tax Exempt money market fund. The goal of the MMMLF is to assist money market funds in meeting redemptions by households and other investors, ensuring proper functioning of the market and flow of credit to the broader economy.
- Eligible Financial Institutions. Under the MMMLF, "eligible financial institutions" include all U.S. depository institutions, U.S. bank holding companies (parent companies incorporated in the United States or their U.S. broker-dealer subsidiaries) or U.S. branches and agencies of foreign banks are eligible to borrow under the Facility.
- One Year Facility. The maturity date of a loan will be the maturity date of the eligible pledged collateral to secure the loan made under the MMMLF, except in no case will the maturity date of a loan exceed 12 months.
- Broad Range of Collateral. Under the MMMLF, assets
must be concurrently purchased and pledged as collateral in order
to secure a loan. An eligible financial institution may not borrow
under the MMMLF against collateral it owned prior to the creation
of the Facility. The following is an exhaustive list of acceptable
collateral under the MMMLF:
- U.S. Treasuries & Fully Guaranteed Agencies;
- Securities issued by U.S. GSEs;
- Rated asset-backed commercial paper that is issued by a U.S. issuer;Rated unsecured commercial paper that is issued by a U.S. issuer; and
- Rated municipal short-term debt that has a maturity that does not exceed 12 months.
A "U.S. issuer" is an entity organized under the laws of the United States or a political subdivision or territory thereof, or is a U.S. branch of a foreign bank.
Also, floating rate instruments are acceptable collateral under the same fixed-rate terms and purchase price as other laons. Accordingly, the interest rate risk will be borne by the borrower.
Commercial paper that has an extendable feature such that the CP maturity date can be extended under certain conditions is not eligible to be pledged to the MMMLF.
In addition, the MMMLF may accept receivables from certain repurchase agreements. However, the facility will not, at this time, accept variable rate demand notes or tender option bonds.
- Credit Protection. The Department of the Treasury would provide $10 billion as credit protection to the Boston Fed using the ESF.
- Regulatory Capital Treatment. The Fed, OCC and FDIC will fully exempt from risk-based capital and leverage requirements (i) any asset pledged to the MMMLF and (ii) any asset purchased from a fund on or after March 18, 2020 that the firm intends to pledge to the MMMLF upon its opening. This is reflected in the agencies' interim final rule published on March 19, which states that a banking organization would be permitted to exclude nonrecourse exposures acquired as part of the MMMLF from its total leverage exposure, average total consolidated assets, advanced approaches-total risk-weighted assets and standardized total risk-weighted assets, as applicable.
- Non-Recourse. Loans made under the MMMLF are made without recourse to the Borrower, provided the requirements of the MMMLF are met.
- Termination. Absent Fed extension, the MMMLF will cease making loans on September 30, 2020.
This facility was established by the Fed under the authority of Section 13(3) of the Federal Reserve Act, with the approval of the Treasury Secretary.
The FAQs issued, among other things, the following clarifications:
- It is not necessary to have a master account with the Boston Fed or any other Federal Reserve Bank in order to borrow under MMMLF. If an eligible financial institution has an account with any Federal Reserve Bank, the loan will settle through the existing account. In addition, eligible financial institutions without a Federal Reserve Bank account may borrow through a correspondent that does have such account.
- The documentation required to participate in the MMMLF will be posted at www.frbdiscountwindow.org. Prior to receiving a loan, a prospective borrower must provide written certifications that it and the money market mutual fund are not insolvent, as the term is used in the Fed's Regulation A.
- Eligible financial institutions may pledge commercial paper bought from proprietary funds under this facility. However, asset purchases are still subject to applicable banking laws, securities laws and all other applicable laws.
The FAQs also addressed specific instructions to follow and documentation necessary to submit when requesting a loan under the MMMLF.
(Updated) Additional Fed Swap Lines
The Fed announced on March 19 the establishment of temporary U.S. dollar liquidity arrangements (swap lines) with additional central banks in order to help bolster global U.S. dollar funding markets. A set of FAQs was released the same day, which provides a policy explanation of this Fed action and description of how the swap lines are structured.
The additional central banks represent countries with which the Fed established lines during the last financial crisis, but which had been allowed to expire.
- Swap Lines. The swap lines will support $60 billion in U.S. dollar liquidity each for the Reserve Bank of Australia, the Banco Central do Brasil, the Bank of Korea, the Banco de Mexico, the Monetary Authority of Singapore, and the Sveriges Riksbank (Sweden). In addition, $30 billion will be available to each of the Danmarks Nationalbank (Denmark), the Norges Bank (Norway) and the Reserve Bank of New Zealand.
- Termination. The swap lines will terminate in 6 months.
- No Change. The Fed maintains its existing swap lines with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank.
(Updated) The Fed's Commercial Paper Funding Facility
The Fed announced on March 17 the establishment of a Commercial Paper Funding Facility (CPFF). An update to the terms of the CPFF was later announced on March 23. In the 2008 financial crisis, the seizing up of the commercial paper market was viewed as having significant knock-on effects, including on money market mutual funds. The Fed aims to encourage continued term lending in the commercial paper market by eliminating the risk that eligible issuers of commercial paper will not be able to repay investors by rolling over their maturing commercial paper obligations.
- Fed Liquidity Facility. The CPFF will provide a liquidity backstop to U.S. issuers of commercial paper through a SPV that will purchase unsecured and asset-backed commercial paper rated A1/P1 (as of March 17, 2020) directly from eligible companies. If such issuer is subsequently downgraded, a one-time sale of commercial paper to the SPV will be permitted so long as the issuer is rated at least A2/P2/F2.
- Treasury Funding. The FRBNY will provide financing to the SPV on a recourse basis, and the obligation of the SPV to the FRBNY will be secured by all of the assets of the SPV. As part of the CPFF, the U.S. Treasury will use the ESF to make an equity investment of $10 billion in the SPV.
- Eligible Issuers of CP. The SPV will purchase from eligible issuers three-month U.S. dollar-denominated commercial paper through the FRBNY's primary dealers. Eligible issuers are U.S. issuers of commercial paper, including municipal issuers and U.S. issuers with a foreign parent company. In addition, the SPV will not purchase commercial paper from issuers that were inactive prior to the creation of the CPFF. Under the CPFF, an issuer will be deemed inactive if it did not issue commercial paper to institutions other than the sponsoring institution for any consecutive period of at least three months between March 16, 2019 and March 16, 2020.
- Limits on SPV Purchases. The SPV may not own more than the greatest amount of U.S. dollar-denominated commercial paper of a single issuer that the issuer had outstanding on any day between March 16, 2019 and March 16, 2020. In addition, the SPV will not purchase additional commercial paper from an issuer whose total commercial paper outstanding to all investors (including the [SPV]) equals or exceeds the issuer's limit. For any issuer that was downgraded from A1/P1/F1 to A2/P2/F2 after March 17, 2020, the SPV will not purchase more of the issuer's commercial paper than the amount of U.S. dollar-denominated commercial paper the issuer had outstanding the day before it was downgraded.
- SPV Pricing. The CPFF's pricing will be based on the then-current three-month overnight index swap rate plus 110 basis points for commercial paper rated A1/P1/F1 and 200 basis points for commercial paper rated A2/P2/F2. Each issuer's facility fee (payable at the time the issuer registers to use the CPFF) will be equal to 10 basis points of the maximum amount of its commercial paper the SPV may own.
- One Year Facility. Absent Fed extension, the CPFF will terminate on March 17, 2021. The FRBNY will continue to fund the SPV after such date until its underlying assets mature.
The Fed has established the CPFF under the authority of Section 13(3) of the Federal Reserve Act, with the approval of the Treasury Secretary.
The Fed's Primary Dealer Credit Facility
In a parallel action, the Fed announced, on March 17, 2020, the establishment of a Primary Dealer Credit Facility (PDCF). In addition, the FRBNY released a set of FAQs concerning the PDCF on March 19.
- Broad Range of Collateral. Under the PDCF, primary dealers of the FRBNY will have access to credit that may be collateralized by, among other things, investment grade corporate debt securities, international agency securities, commercial paper, municipal bonds, mortgage-backed securities, asset backed securities, as well as certain equity securities. Foreign currency denominated securities are not among the eligible collateral, however. The Fed has also kept open the possibility of adding additional collateral in the future.
- Interest Rate. The FRBNY will offer overnight and term funding with maturities up to 90 days beginning on March 20. (This is a difference from the PDCF offered between 2008 and 2010, which only provided overnight loans.) The interest rate charged will be the primary credit rate, or discount rate, at the FRBNY. Loans will be made recourse to the primary dealer entity.
- Six Month Facility. The PDCF will be in place for the next six months, unless extended.
Notably, the FAQs clarifies, among other things, how funding provided through the PDCF will be treated with respect to the Liquidity Coverage Ratio (LCR). According to the FRBNY, entities subject to the LCR rule are not be required to recognize an outflow for a secured funding transaction that matures more than 30 calendar days from the calculation date. Accordingly, primary dealers that are affiliates of entities subject to the LCR rule would not recognize an outflow for so long as the maturity of the loan is not within 30 calendar days of a firm's calculation date. The FRBNY noted that as the remaining maturity of the loan declines, the primary dealer may choose to pre-pay the loan and request a new loan up to 90 days.
This facility was also established by the Fed under the authority of Section 13(3) of the Federal Reserve Act, with the approval of the Treasury Secretary. The FAQs also note that borrowing will be disclosed in accordance with Section 13(3).
(Updated) Easing of Capital Requirements
The Fed announced on March 23 the issuance of an interim final rule to phase in gradually the automatic restrictions associated with a firm's total loss absorbing capacity, or TLAC, buffer requirements. Similar to the March 17 interim final rule described below, the purpose of this interim final rule is to revise the definition of "eligible retained income" so that, if there are reductions in capital ratios, the limitations on capital distributions apply in a more gradual manner rather than in a sudden and severe manner.
The Fed, OCC and FDIC also announced on March 17 a technical change to their capital regulations to phase in gradually the restrictions on capital distributions and discretionary bonus payments that automatically apply if a bank's capital levels decline. The change was made by the issuance of an interim final rule that will be effective upon its publication in the Federal Register (expected in a few days after the announcement).
- The interim rule revises the definition of "eligible retained income" for all depository institutions, bank holding companies and savings and loan holding companies subject to the agencies' capital rule. The revised definition will make limitations on capital distributions that would have been automatic instead apply more gradually.
- This interim final rule was released in tandem with a statement by the agencies urging banking organizations to use their capital and liquidity buffers as they respond to the challenges presented by the effects of the coronavirus.
- The agencies noted that the changes made by the interim final rule do not impact other rules that may limit capital distributions or discretionary bonus payments.
Fed Discount Window and Reserve Requirements
The Fed announced on March 15 (a Sunday) that it would cut its benchmark federal funds rate by a full percentage point to zero. As of the date of this publication, the Fed Funds target rate was in a range of 0 to 0.25 percent, down from a range of 1 to 1.25 percent.
- Aiming to instill confidence in the market, a group of major banks announced they had accessed the Fed Discount Window (which in normal circumstances might be seen as a sign of financial weakness) shortly after the Fed and other banking agencies urged banks to do so on March 16. On March 15, the Fed had lowered the primary credit rate by 1.5 percent to 0.25 percent.
- The Fed also reduced the reserve requirement ratios to zero percent on March 15, 2020. This reduction will be effective on March 26, 2020, which marks the beginning of the next reserve maintenance period. The Fed has not indicated whether weekly reporting of deposits will continue.
Also on March 15, the Fed, together with the European Central Bank, Bank of England, Bank of Japan and the Swiss National Bank, announced coordinated action to enhance liquidity through standing U.S. dollar liquidity swap line arrangements. The pricing on such arrangements will be the U.S. dollar overnight index swap rate plus 25 basis points, which represents a reduction in the rate by 25 basis points.
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