Federal Reserve Amends Pricing, Adds Municipal Issuers, and Makes Other Changes for Recently Established Commercial Paper Funding Facility

Client Alert
On March 17, 2020, the Federal Reserve Board announced the establishment of two emergency funding facilities that closely mirror facilities established in 2008 during the last financial crisis in providing liquidity to both short and long term funding markets. The facilities are generally directed at government backed and private issuer rated, traded securities, as well as some traded equity securities, not less liquid credit markets, such as bank loans to unrated companies. On March 23, 2020, the Federal Reserve added municipal issuers and amended the pricing for the commercial paper funding facility announced on March 17 and issued other “program terms and conditions” posted on the website of the Federal Reserve Bank of New York. To reflect these changes, this client alert replaces in full our March 19, 2020 client alert, “Federal Reserve Establishes Special Commercial Paper Backstop and Primary Dealer Funding Facilities.” 

The commercial paper facility is directed at issuers (and carries a higher than “normal” interest rate). The primary dealer facility is directed at providing those dealers (most of which are broker-dealers affiliated with commercial banks)¹ with liquidity on a par with the liquidity provided to commercial banks through Federal Reserve Bank “discount windows” for securities they hold. Both facilities provide for short term loans (no longer than 90 days), but the lenders under those facilities can renew such financing, at their discretion, through new loans or commercial paper purchases.

Commercial Paper Funding Facility. This facility (the CPFF) closely tracks the 2008 commercial funding facility established during the last financial crisis. As with that facility, the Federal Reserve Bank of New York will lend to a special purpose vehicle (SPV) that will use that funding to purchase rated three-month U.S. dollar denominated commercial paper.

The CPFF provides that eligible “issuers are U.S. issuers of commercial paper, including municipal issuers and U.S. issuers with a foreign parent company.”

Whereas the 2008 facility required the commercial paper be rated A-1/P-1 by a major rating agency (recognized statistical rating organization or NRSO) the new facility will permit a one time purchase of A-2/P-2/F-2 rated paper, if the issuer was rated A-1/P-1 on March 17, 2020.²  Such purchase would be limited to the amount of commercial paper the issuer had outstanding “the day before it was downgraded.”³ Otherwise, the purchased commercial paper must be rated A-1/P-1/F-1. As with the 2008 facility, commercial paper rated by more than one NRSO must receive the minimum rating from at least 2 NRSOs.

Also similar to the 2008 facility, purchases of commercial paper from any issuer are limited to the largest amount of commercial paper such issuer had outstanding during the one year period from March 16, 2019, to March 16, 2020 (i.e., the day before the facility was announced)⁴minus the amount of such paper held by investors other than the SPV (i.e., the SPV is only intended to support the issuer maintaining total CP funding up to its largest amount of such funding during the 1 year plus one day period preceding March 17, 2020).⁵

The interest rate for commercial paper purchases under the CPFF will be 1.10% plus the overnight index swap (OIS) rate, except that commercial paper rated A2/P2/F2 at the time of purchase will be purchased at the same 2% spread over OIS as for all purchase under the original pricing announced on March 18, 2020,⁶ and each issuer using the facility will be required to pay a fee equal to 0.10% of the maximum amount of commercial paper it had outstanding during the one year and 1 day period described above (i.e., 10bps on the maximum amount of CP the SPV can purchase from that issuer).

In another modification to the terms announced on March 18, 2020, purchases of ABCP  will not be made “from issuers that were inactive prior to the creation of the CPFF. An issuer will be deemed inactive if it did not issue ABCP to institutions other than the sponsoring institution for any consecutive period of three-months or longer between March 16, 2019 and March 16, 2020.”

Other terms of the facility are outlined in the “program terms and conditions” attached as Attachment I to this client alert.

Primary Dealer Credit Facility. Similar to the 2008 term securities lending facility that permitted primary dealers (PDs)to bid on funding for certain term securities they held in inventory, this new facility (PDCF) is available only to primary dealers.⁷ Unlike the new CPFF, the PDCF is intended to support liquidity in longer term debt and even equity markets (as well as commercial paper markets). Any PD can receive a short term loan from the FRBNY collateralized by securities eligible for FRBNY “open market” operations (i.e., “OMO eligible securities), plus Treasury strips, and “investment grade corporate debt securities, international agency securities, commercial paper, municipal securities, mortgage-backed securities, and asset-backed securities; plus equity securities.⁸”

Any such collateral must be rated investment grade (defined as BBB- or higher), except CDOs, CLOs, and CMBS must be rated AAA and commercial paper must be rated at least A2/P2.

In addition, all pledged collateral must be eligible for pricing by Bank of New York Mellon as the clearing bank for the transactions and be valued “according to a schedule designed to be similar to the margin schedule for lending by the Discount Window, to the extent possible.”

The facility extends to primary dealers funding similar to discount window lending by Federal Reserve Banks (with more limited eligible collateral), much like the primary dealer funding facility first established in March 2008 following the Bear Stearns “rescue.” The lending rate will be “equal to the primary credit rate in effect at the New York Fed offered to depository institutions via the Discount Window.”

On March 15, 2020, the Federal Reserve Board reduced that rate to 0.25% (from 1.75%) to reflect a simultaneous reduction in the federal funds target rate and to reduce (virtually eliminate) the spread between the primary credit rate and the target overnight rate.⁹ Thus, unlike the rate for loans under the CPFF, there is no “penalty” feature to the interest rate, which is consistent with the Federal Reserve’s desire, expressed in its March 15, 2020, press release announcing the reduction in the discount rate, that banks freely use the discount window with no thought of negative consequences, reputational or otherwise. Presumably, the Federal Reserve intends the same for PDs under the PDCF.

Other terms of the facility are outlined in its “term sheet” attached as Attachment II to this client alert.

1. The FRBNY website currently lists 24 primary dealers. https://www.newyorkfed.org/markets/primarydealers
2. Subject to the same requirement noted above that, if rated by more than one NRSO, at least two NRSOs had assigned such rating.
3. As announced on March 18, 2020, the limit was the amount of commercial paper the issuer had outstanding on March 17, 2020.
4. The 2008 facility limited purchases to the outstanding commercial paper of the issuer during the 8 month period from January 1 through August 31, 2008.
5. This limits purchases by the SPV. After the SPV makes purchases, outside funding could cause an issuer’s outstanding commercial paper to exceed the largest amount it had outstanding between March 16, 2019, and March 16, 2020, but the SPV could only make additional purchases to the extent such limit would not be exceeded. 
6. As announced on March 18, 2020, such purchases were to have “separate pricing.”
7. Footnote 1 above lists the current primary dealers.
8. Excluding exchange traded funds (ETFs), unit investment trusts, mutual funds, rights and warrants.
9. https://www.federalreserve.gov/newsevents/pressreleases/monetary20200315b.htm

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