PACE Financing: A Brief Overview

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This week I decided to take some time to write about one of the financing structures I find the most interesting – Property Assessed Clean Energy (PACE).  PACE is an innovative structure that makes it possible for owners of residential and non-residential asset classes to obtain relatively low-cost, long-term financing for projects that leverage energy efficiency, water conservation, seismic strengthening, and renewable energy sources (such as solar, wind, and biofuels). PACE is a program authorized at the state level and implemented at the municipal and county levels that allows coordination with private capital providers to offer financing to property owners for qualifying improvement projects. This post will provide a quick breakdown of how PACE programs are structured and how PACE fits in a typical capital stack for a commercial real estate transaction.

PACE Program Structure

PACE was originally introduced in California in 2007 as a form of assessment financing to fund improvements to “qualifying properties,” namely properties that reduce energy and water usage, leverage a renewable energy source, enhance the resiliency of a structure, and which are ultimately considered a public good. There are currently 36 states that have approved the PACE structure in the U.S., below is a breakdown of how a PACE program is implemented through legislation and funded via a private capital source.

  • State legislature must approve PACE legislation.
  • Counties and/or cities are able to “opt-in” to the PACE based on the program implemented at the state level.
  • The source of private capital (typically a fund) will essentially underwrite the PACE financing as a loan to ensure eligible borrowers have adequate repayment capacity.
  • Once underwritten, the PACE transaction is submitted for program approval. Upon receipt of approval, the transaction is funded (typically through bond proceeds).
  • Post-funding, the transaction is recorded by the county/municipality as an additional line item added to the property’s tax assessment. The PACE assessment is collected bi-annually or annually with the normal tax assessment and then remitted to private capital source for repayment.

To put it simply, PACE is originated as a debt instrument and assessed as an addition to property taxes. Though the PACE assessment is structured similarly to a mortgage, repayment is filtered through the county or municipality. However, unlike a mortgage, a deed of trust is not filed as part of the recording process for the transaction. Therefore, PACE financing is ultimately tied to the property and not the borrower. If the borrower decides to sell the property, they are required to provide documentation recording the PACE assessment, but they are not required to pay off the assessment. The assessment remains with the subject property until it is repaid.

PACE in the Capital Stack

In commercial real estate transactions PACE is typically utilized to replace expensive mezzanine debt (or equity, depending on the size/scope of the transaction). A typical financing structure or “capital stack” is comprised of (1) a senior bank note and equity from partners/investors or (2) a senior bank note, mezzanine debt, and equity – depending on project/sponsor level constraints. Moreover, mezzanine debt tends to carry a shorter time horizon of 5-10 years. As discussed above, PACE financing is structured like a mortgage with a time horizon of 25-30 years.

Stretching out the time horizon can make the project bankable as the payments over a longer period can reduce debt service burdens. Mezzanine debt is relatively expensive, usually priced at a rate of 10-15%. In addition to a longer maturity, PACE financing is priced more competitively, around 5.5-7%. Finally, PACE financing usually accounts for a larger amount of the capital stack than you would see with mezzanine debt. The illustration below captures the benefits described in this section and provides a side by side view of a typical mezzanine structure compared to a PACE structure.

Source: CleanFund

Though not applicable to all transaction types, PACE provides a competitive alternative to equity and mezzanine financing when developing or retrofitting a property with energy efficiency in mind. Moreover, this type of financing strikes a good balance between financial flexibility and renewable energy incentives which makes it attractive to a large base of developers – hopefully expanding the reach of sustainable development at the urban level.

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Credit Creation Theory

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As discussed in my previous post, this week I will be focusing on specifically on the credit creation theory of banking. Dr. Werner ultimately makes the case that this is the most compelling theory of banking because it most accurately depicts how the current financial system functions at the transactional level. I tend to agree with his assessment and find the credit creation theory to be a helpful lens through which to view the current financial system. Moreover, if you accept the tenets of this theory, deficits in monetary policy and banking regulations start to appear. This post will focus on the concept of money, how it is circulated and the logic of credit creation.

The Concept of Money & How it is Circulated

Money within an economy can take several forms. The most common forms are notes, coins, and credit. Precious metals such as gold and silver are also prominent forms of money. However, only about 3% of the money in circulation is derived from cash or coins. The overwhelming majority of the money in circulation, ~97%, is comprised of credit originated by banks. This credit is derived from bank deposits and circulated through the economy in the form of loans. A bank effectively creates credit money when generating a bank deposit that is a consequence of fulfilling a loan agreement with a borrower. When the debt instrument is executed, the bank deposits the agreed upon sum into the borrower’s account.

Credit money represents the total amount of money that is owed to banks by borrowers and it only remains valid so long as the bank is solvent. Though it is intuitive to assume that as a loan is paid back to a bank the money supply would expand, the opposite is actually true. Bank deposits basically represent an IOU between a commercial bank and their clients (represented by both individuals and organizations). Again, when a commercial bank lends money, they are technically creating a deposit in another account. Moreover, when individuals deposit their money in a bank they are technically serving as a creditor to the bank, which in turn reserves the right to deploy the depositors’ capital as they see fit. This dynamic is important to understand in order to grasp the credit creation theory of banking at a high level.

The Logic of Credit Creation

As mentioned previously, the dominant theories of banking have been the intermediation theory and fractional reserve theory. These are the theories that are most often taught in college level business, economics, and finance courses. Credit creation theory is seldom considered in academia, however the Bank of England recently published a paper which recognizes the credit creation theory as useful and practical. The theory proposes that individual banks create money and do not solely have to draw upon existing deposits. Instead, the banks create deposits with each loan they originate. As a result, banks are not actually constrained by their deposit activities. By virtue of the bank’s lending, new purchasing power is created which did not previously exist.

The argument for credit creation theory works like this – banks act as the ‘accountant of record’ within the financial system, which enables them to create the fiction that the debtor has deposited money at the bank. The general public is unable to distinguish between money that a bank has created through debt instruments and money deposited at the bank by individuals. Moreover, banks’ ability to create credit money has had significant impacts in the economy – as stated previously, ~97% of all transactions taking place in the economy are considered non-cash or credit transactions. These transactions are settled with non-cash transfers within the banking system as a whole. Ultimately, this theory makes the case that banks are capable of creating an endless supply of money through their lending activities. When viewed from this perspective, current and past financial crises, as well as interventions from the Fed begin to make sense.

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The Three Theories of Banking: An Overview

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I have already published a few posts regarding the Federal Reserve and the credit facilities it has developed in an attempt to mitigate the financial crisis resulting from the COVID-19 pandemic. However, I thought it would be beneficial to take a step back and explore a more fundamental topic – how does banking work? This is a topic that I’ve been interested in discussing for a while and I think now is a great time to explore it. The answer to the question of how banking works is more complicated than many realize. Moreover, it is still a topic that remains open to debate within the realm of economics.

One of the most compelling arguments that I’ve come across stems from the work of German economist Richard Werner. He provides three mutually exclusive theories of banking, ultimately making the case that one in particular is the empirically correct way to understand how banking works in practice. The three theories put forward by Dr. Werner are the financial intermediation theory, the fractional reserve theory and the credit creation theory.  It is important to grapple with these theories because the way banking is conceived of and carried out in practice will ultimately have profound implications for how banking policies, monetary policies, and bank regulations are implemented. For the purposes of this post, I will be focusing on the three theories of banking presented above and how they are unique from each other.

Financial Intermediation Theory

This is the presently dominant theory of banking. It holds that banks are merely financial intermediaries, undiscernible from other non-bank financial institutions: they gather deposits from clients and use them to make loans. Put another way, banks are “borrowing” money from their depositors in the short term and using that money to make long term loans to borrowers. This theory of banking is publicized by highly ranked economics journal and has also been lauded by well known economists such as Keynes and Mises, with Mises being one of its earliest proponents. The more recent views of this theory, as put forth by the likes of Ben Bernanke, double down on the notion that banks are simply financial intermediaries, one among many, with the power to create credit or money. The key distinction here is that banks and other financial intermediaries do not create money, they can only repurpose existing funds – effectively swapping one asset for another.

Fractional Reserve Theory of Banking

This theory of banking also makes the case that each bank serves as a financial intermediary, but it takes a more nuanced approach than the former. For example, this theory disagrees with the collective notion that banks are solely financial intermediaries, indistinguishable from others, incapable of creating money. Rather, it argues that “together” the banking system does create money through the process of depository expansion. This process is also referred to as the “money multiplier” process. While each bank serves as a financial intermediary, the banking system as a whole is capable of creating new money. Fractional reserve banking effectively means that banks can lend in excess of their reserves, while the total amount outstanding must remain equal to total deposits. Typically, banks are only required to hold 8-10% of their outstanding loan balances in reserves. An important caveat here is that, just like in the financial intermediation theory, banks cannot make loans without having depositors. The nuanced part of this is that banks are only required to allocate a small percentage of their deposits to reserves, while lending out the rest. These new loans become inevitably create multiple new deposits throughout the financial system, which has the aggregate effect of creating new money.

Credit Creation Theory

The third theory of banking is at odds with the other two theories presented above. Unlike financial intermediation and fractional reserve approaches, the credit creation theory asserts that banks are not financial intermediaries in any sense. Rather, each bank is said to be capable of creating credit and money out of nothing whenever it executes a bank loan contract or purchases an asset. From this perspective, banks are not required to gather deposits or allocate reserves in order to lend. This theory posits the opposite – that banks create deposits whenever they originate a loan. The argument being made here actually has less to do with finance and more to do with the law. When a bank originates a loan, what takes place legally is the execution of a legal document. This legal document is a “debt instrument” that the bank is technically purchasing from the borrower under a particular set of conditions (i.e. the sum being purchased by the bank now, will be repaid in the future with interest). Through this purchase, the bank creates a deposit and records it as such on its books. Therefore, at the end of the transaction, money has been created that did not exist prior.


This concludes my brief overview of the theories of banking. Most are probably familiar with the financial intermediation and fractional reserve theories, especially if they have taken contemporary courses in finance, economics, or business. What I found the most interesting in Werner’s work was the notion of credit creation, as it was, for me, a novel concept with some interesting implications. In future blogs I will focus more on this topic and expand on more on the credit creation theory. As always, if you found this information valuable please like, share, and subscribe to my content.

A Glimmer of Hope – Mortgage Refinancing in the Wake of Coronavirus

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The financial markets have experienced unprecedented levels of volatility resulting from the Coronavirus pandemic. These swings in the market have prompted equally unprecedented responses from the Federal Reserve and U.S. Treasury with the aims of providing relative stability to the financial system. I have written extensively about the responses taken by the Fed over the last month, providing mostly overviews and critiques of certain credit facilities. Moving forward, I’d like to highlight something that has emerged as a financial silver lining amongst the chaos – increased utility from and demand for mortgage refinancing.

A significant result of the turmoil we’ve seen in the financial markets has been rate cuts. The Fed cut rates to near zero at the beginning of the pandemic to quell the market and incentivize borrowing. The lower rates have generated a boon in demand for mortgage refinancing. According to the Wall Street Journal average jumbo loan rates dropped to their lowest levels since 2011 – 3.58%. Given the current circumstances, it is likely that rates will remain low. Excessive demand for mortgage refis may result in minor rate hikes, but in general the incentives to refi will remain intact.

Moreover, given the combination of massive losses of income, low rates, and a boon in home equity over the past 10 years, families and individuals will be looking to cash in on the equity they’ve accumulated. Home equity can provide a much needed buffer for households that have experienced a reduction or complete loss of income. Fortunately, given the low rate environment and demand for mortgage backed securities (MBS) enhanced by the Fed, households find themselves in an opportune position to access the capital they need. However, the current state of affairs presents a dynamic situation. Prospective borrowers should familiarize themselves with potential disruptions in the process as well as easy to make, but avoidable mistakes. A few examples of each will be presented below.

Potential Disruptions

I read a great article from Brookings that explored several potential disruptions and also laid out a set of policy solutions for each. I highly recommend reading it if you’re interest in more than a cursory overview of the mortgage space. For the sake of this post, I’ve isolated the two disruptions I considered to be the most important for prospective borrowers to be aware of – verification of employment and closing.

First, mortgage refis currently require some form of employment verification; this is a difficult requirement to meet in the current environment when so many employers have been forced to shut down in the midst of the pandemic. Fortunately, Fannie Mae and Freddie Mac have provided some flexibility to the situation by allowing employers to verify employment status via email. Moreover, this requirement can also be met with a paystub or bank statement and the lender can wait to obtain verification up to loan closing. This step is key and all lenders will want to maintain it as part of their underwriting process to some degree. Moreover, Fannie and Freddie have both required lenders to engage in due diligence to ensure continuity of income during the pandemic as a condition to guarantee the loan. Conventional lenders will have more flexibility to address repayment capacity, but since a significant portion of mortgage lending incentives are provided through Fannie and Freddie, this may present a significant pitfall for prospective borrowers. This is particularly true for those who are self-employed.

Second, the closing process for these loans is complicated in the current environment because many homeowners will be unwilling to allow a notary into their home to physically execute closing documents. Conversely, many notaries are likely to resist entering a stranger’s home. A majority of states do not allow e-notarizations, but fortunately this is changing. Currently, 23 states allow for virtual signings, with New York being the most recent addition as of March 20th.  Additionally, there are an increasing amount of Fintech lenders adopting the e-notarization standard as the default for closing loans – Figure Technologies is an excellent example.

Mistakes to Avoid

The two most important considerations prior to initiating a mortgage refi are getting appraisal ready and making sure your credit situation is lean. First, make sure that your home is appraisal ready before engaging a lender. Since the appraisal will ultimately determine how much equity you can withdraw from your house, it is imperative that everything is in order prior to ordering an appraisal. If you’re considering home improvements or in the midst of completing them, make sure they are completed in advance. The house should not be under construction at any point during the appraisal process. Ultimately, the key is to ensure your home is as immaculate as possible to maximize the valuation at the time of refinance.

Second, make sure your credit situation is pristine. Do not open a new auto loan, line of credit, etc immediately before or during the mortgage process. New debt creates several issues that can impact your ability to qualify. This is especially important during the pandemic, as repayment capacity will be heavily scrutinized. Moreover, as lenders gear up to process a slew of refi requests, they will inevitably run into problems with capacity. In normal times, lenders would just hire and train new loan officers, but the pandemic has inhibited hiring in a majority of sectors, not just mortgage lending. As capacity is stretched thin, lenders will likely place a premium on borrowers with the best credit situation. The more you can do to enhance your repayment capacity, the better.

This wraps up my post on mortgage refinancing in the wake of Coronavirus. As always, if you found this information valuable please like, share, and subscribe to my content.

Main Street Lending Program – What Businesses Should Know

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On April 9th, 2020 the Federal Reserve announced the creation of the Main Street Lending Program – a novel pair of credit facilities that will provide credit to eligible businesses with a maximum of 10,000 employees or a maximum of $2.5 billion in annual revenues. The Program will achieve this by purchasing up to $600 billion in loans.

The Program’s facilities are designed to support lending to both investment-grade and below investment-grade borrowers. Moreover, these facilities are separate from the other mid-sized business loan program contemplated in the CARES Act. Since I dedicated last week to expanding on the programs designed for large firms, I wanted to take some time this week to dive into the Fed’s solution for medium-sized businesses. I’ll start by providing an overview of the two facilities that comprise the Main Street Loan Program and then wrap up the post by identifying potential risks businesses should be aware of before applying for relief under this program.


The Program is comprised of two facilities: first, the Main Street New Loan Facility (MSNLF) applies to eligible unsecured new terms loans originated on or after April 8th, 2020. Second, the Main Street Expanded Loan Facility (MSELF) applies to eligible “upsized tranches” (sometimes referred to as debt accordions) to existing secured or unsecured loans originated before April 8th, 2020 (provided the upsize occurs on or before April 8th, 2020). The primary differences between the terms of the two facilities relate to maximum loan amounts and collateral requirements (see table below).

Similar to the other Fed facilities explored on this blog, the Main Street Lending Program will utilize an SPV to facilitate transactions. Specifically, the SPV will purchase a 95% stake in each of the loans made to borrowers under the program and eligible lenders will retain the remaining 5%. The SPV will be seeded by $75 billion from the Treasury and will utilize leverage to meet the $600 billion obligation discussed above. Eligible lenders are U.S. insured depository institutions, U.S. bank holding companies, and U.S. savings and loan holding companies. Non-bank lenders are currently ineligible.

Table 1 – Differences Between MSNLF and MSELF:

Source: Miller Canfield

Risks for Businesses

First, unlike the PPP loan program, loans made under the Main Street Program need to be repaid in full. There are no provisions for loan forgiveness under this program. As shown above, the loans are underwritten to 4 year terms with variable interest rates. Repayment can be deferred for up to 1 year, but this is only grace period allowed.

Second, despite being called the Main Street Lending Program, the minimum loan amounts for both credit facilities are $1,000,000 – a far larger sum than is normal and customary for small-to-medium sized business loans. Typically, a commercial bank will lend up to 2-3 times a borrower’s earnings before interest, taxes, depreciation and amortization (EBITDA) and require some form of collateral. For many small businesses, 2-3 times EBITDA still falls well below $1,000,000. Under the Main Street Program facilities, many small businesses would be required to leverage themselves 4-6 times above EBITDA (depending on whether or not they are accepting a new loan, or adding on to an existing loan). Banks tend to be hesitant about providing excess leverage, as the likelihood of default increases when repayment capacity is diminished or all together inadequate. Conversely, there are few incentives for a small-to-medium sized business to take on excessive leverage given the 4 year expiry and variable rate.

Finally, it is also important to consider the fact that some lenders may not be interested in originating these loans. As currently written, the Fed’s term sheet implies that loans made under the Main Street Program will be senior to any other existing notes. Moreover, the Main Street Program facilities cannot be utilized to refinance existing debt. While it is still unclear to what degree these loans will be made senior over others, the ambiguity in the existing term sheet doesn’t help much in terms of establishing buy-in from eligible lenders. Ultimately, it appears that significant deterrents exist on both sides of the equation. While the impact of the Main Street Lending Program remains to be seen, I believe the overall result will unfortunately be underwhelming.

As always, thank you for taking the time to read my thoughts. If you found this information valuable, please be sure to like, subscribe and share with others.

Secondary Market Corporate Credit Facility: Analysis and Consequences

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Earlier this week I wrote about the Primary Market Corporate Credit Facility (PMCCF). Today, I will follow up with an analysis of its counterpart – the Secondary Market Corporate Credit Facility (SMCCF). The SMCCF and PMCCF both aim to support the flow of credit to large firms. The key difference between the two is that the SMCCF supports liquidity in existing markets, while the PMCCF is designed to support new bond and loan issuances. Similar to the PMCCF, the SMCCF will take the form of an SPV that will purchase existing individual corporate bonds as well as corporate bond portfolios in the secondary market.

The facility works like this – the Federal Reserve Bank of New York (FRBNY) will lend to the aforementioned SPV on a recourse basis and the FRBNY’s loans will be fully secured by the entirety of the assets held by the SPV. Finally, the Treasury will seed the SPV with $10 billion using the Exchange Stabilization Fund, the FRBNY will in turn leverage the $10 billion investment to purchase existing bonds and bond portfolios in the secondary markets. I will highlight what I consider to be the most important aspects of the SMCCF and discuss potential consequences of the facility below.

Key Aspects

The SMCCF will mirror the guidelines of the PMCCF when it comes to the purchase of individual corporate bonds – they must be BBB or better by a major NRSRO. Specific to SMCCF is that the bond being purchased must have a remaining maturity of five years or less to be eligible. Moreover, the SMCCF will be purchasing eligible bonds at fair market value in the secondary market. The rationale here is that the FRBNY will, through the SPV, mitigate existing volatility and provide stability in the credit markets by insuring there remains a buyer for existing corporate debt.

In addition to individual corporate bonds, the SMCCF will purchase corporate bond portfolios which (for now) are only limited to exchange traded funds (ETFs). This is, in my opinion, the most profound point of departure we’ve seen the Fed take over the course of the pandemic and it is certainly unprecedented. The investment objective here is to provide broad exposure to the market for U.S. investment-grade corporate bonds. The specifics are presented below:

  • The SMCCF can purchase up to 10% of an issuer’s maximum bonds outstanding at any time between March 22, 2019 and March 22, 2020.
  • The SMCCF can purchase up to 20% of the assets of any one ETF as of March 22, 2020.
  • Finally, and this is a key provision, the SMCCF will not purchase shares of ETFs at a price that materially exceeds the estimated net asset value of the ETF’s underlying portfolio. This is supposed to mitigate substantial losses, should the portfolios buckle.

Both eligible purchases under the SMCCF will have tangible impacts in the secondary markets, but my primary focus for this piece will be to drill down on the former. As stated previously, the Fed making direct investments in the corporate bond portfolios is certainly a new frontier that is sure to result in a slew of consequences, both intended and unintended.

Consequences of the SMCCF

In my opinion, the most interesting consequence has been the market’s reaction to the announcement of the new facility. Companies have started issuing massive sums of corporate debt in anticipation of the SMCCF and the HYG Fund (a corporate bond ETF) experienced its most significant single day spike in value since 2009 late last week (depicted below).

Source – segment: Fixed Income: U.S. – Corporate, Broad-based High Yield

Again, keep in mind that this spike was wholly attributed to the Fed’s announcement. The facility has yet to be implemented and therefore no bonds or shares of bond ETFs have been acquired by the Fed through the SMCCF. In my post about the PMCCF, I expressed concern that it was effectively a bailout for imprudent firms, that it sent the message that bad behavior is acceptable. The same is true of the SMCCF, as it will provide liquidity for existing corporate bonds that would otherwise collapse. However, the speculation that it will drive in bond portfolios such as the HYG Fund is far more concerning.

Facilitating artificial growth in the corporate bond markets is dangerous because these credit facilities are effectively propping up what can be objectively considered poor investments in overleveraged firms. In doing so, they are overriding a fundamental truth – firms that egregiously mismanage money are ultimately supposed to fail. This is no longer the case, so long as a firm is large enough to issue corporate debt they will be empowered to do so. This will maintain a status quo that routinely punishes other firms and investors for making prudent financial decisions.


Finally, I think it is important to mention that all of this is occurring in the midst of record high unemployment filings. Each week the numbered of unemployed expands, demonstrating profound strife in the real economy. However, this inconvenient truth appears to have no bearing on the stock market as stocks once again begin to rise in the midst of these new Fed credit facilities. I mentioned above that the HYG Fund experienced it’s largest single one day valuation spike since 2009 last week – this occurred after unemployment filings were recorded in excess of 6 million. The most recent filings, adding an additional 5.2 million to initial jobless claims, are presented below.

Source – YCharts: US Initial Jobless Claims

Unfortunately, these figures once again coincide with an uptick in equity futures. Below is a graph chronicling activity within the NASDAQ Composite index over the course of today, signaling an ever-expanding chasm between Wall Street and Main Street.

Source – Yahoo Finance: NASDAQ GIDS Real Time Price

As always, thank you for taking the time to read my thoughts. If you found this information valuable, please be sure to like, subscribe and share with others. Additionally, please feel free to weigh in on these topics, I’d love to see what others are thinking!

Primary Market Corporate Credit Facility: How it Works and Where it Falls Short

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As promised, this post will expand more on the Primary Market Corporate Credit Facility (PMCCF) and address potential shortcomings. In my overview post, I outlined the mechanics of the PMCF, but didn’t provide any color on key points. In this post I will isolate what I consider the most important aspects of this facility to explain how it will work in practice. Once we have an understanding of the “fine print” we can move into a discussion about who will reap the most benefits from its implementation and address what I consider to be legitimate shortfalls with this facility.

The Fine Print

The term sheet provided for the PMCCF is relatively straight forward regarding eligibility, loan maximums, and fees. However, it takes some digging to understand an important relationship between the CARES Act and this facility. The CARES Act prohibits the payment of dividends and share buybacks, while also placing restrictions on executive level compensation until 12 months after a loan has been repaid. These are arguably the most lauded provisions of the Act as they are intended to reign in the behavior of large firms to ensure they allocate relief funding in a way that is beneficial to the employees.

Unfortunately, this provision does not apply to the PMCCF as the SPV established by the Fed to orchestrate this facility will only be purchasing bonds and syndicated, which are not direct loans pursuant to the CARES Act. The direct implication of this is that eligible issuers will be allowed to issue additional debt to a captive audience, without any prohibitions on how proceeds will be spent. Therefore, the PMCCF is more or less incentivizing the behavior that lead to a myriad of firms facing liquidity and solvency issues in the wake of the pandemic.

Now that the CARES Act loophole has been addressed, it’s important to understand how the debt limits associated with this facility are calculated. The PMCCF limits the amount of total outstanding bonds or loans for an eligible issuer participating in the facility to 130 percent of the eligible issuer’s maximum outstanding bonds and loans on any day between March 22, 2019 and March 22, 2020. For example, let’s say company A’s maximum outstanding bond and loan obligations for the period described is $2 billion. Under the PMCCF, Company A is allowed to issue an additional $600 million of bonds or loans directly to the PMCCF SPV.

Finally, let’s expand more on the notion of eligibility. Eligible issuers must have an investment-grade of at least BBB as of March 22, 2020 by a major NRSRO, which is essentially the lowest rating a bond can have while still being considered “adequate.” A BBB rating indicates medium quality, which is generous considering anything below a BBB rating is categorized as “junk” due to their highly speculative and risky nature. So, what’s the problem? The Fed has drawn the line at BBB, effectively mitigating the risk of highly speculative purchases, right? Wrong. There is an important caveat to this eligibility requirement – if the issuer was rated at least BBB as of March 22, 2020, but was subsequently downgraded, it must be rated at least BB at the time the PMCCF SPV makes a purchase. This effectively opens the floodgates to a slew of eligible junk rated bonds that will be picked up by the Fed, no questions asked.


The direct lending program under the PMCCF is truly an unprecedented effort by the federal government and Federal Reserve to provide liquidity directly to investment-grade corporate borrowers. In the past, the Fed would coordinate with banks to facilitate access to capital. Given the present circumstances, there are concerns that banks will be limited in their ability to provide credit to such borrowers due to existing leverage and regulatory capital requirements. Having cut the middle man out of the equation, the Fed’s new program will likely be an effective tool for investment-grade borrowers in need of refinancing or other immediate funding needs.

Ultimately, however, a strong case can be made that the PMCCF is essentially a bailout for reckless companies. Given the fact that the CARES Act prohibitions will not apply to participants in this facility, there is really no incentive to improve the behavior which placed many of the investment-grade borrowers in this position to begin with. As a result, the Fed has sent the following message – “there are no consequences for bad behavior, in fact it gets rewarded.”

As always, if you found this content valuable please like, subscribe and share it with others. Additionally, if you have thoughts of your own that you’d like me to consider please share them!

TALF: A Looming Deficit

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Last week I published a blog post that outlined the credit facilities introduced by the Federal Reserve to address the impact Coronavirus has had on the financial markets and real economy. My introduction to that post did not shy away from the fact that I had some reservations and misgivings about the decisions made by the Fed. I stated that I would expand on these misgivings in more detail in future posts, so this week I will follow through on that statement. I am going to discuss issues I have with three credit facilities in particular in separate posts: Term Asset-Backed Securities Loan Facility, Primary Market Corporate Credit Facility, and Secondary Market Corporate Credit Facility. I will begin with TALF.

The Missing Market

I’d like to start off by stating that I understand the impetus for TALF and believe it will provide stability to lenders and allow them to support borrowers through the crisis. The rationale is essentially that this will allow lenders to continue extending credit since the Fed will step in and maintain the market for asset backed securities. However, as American Banker has pointed out, the 2020 version is ill equipped to fully address the existing market for these loans. This credit facility neglects a significant aspect of the contemporary market – the prominence of unsecured consumer loans.

According to Kroll Bond Rating Agency (KBRA), approximately $10 billion of consumer loan backed ABS was originated in 2019. These loans were primarily originated by nonbank lenders, also known as “fintechs” (financial technology companies). These loans are typically considered investment-grade (i.e. they have a higher interest rate associated with them in lieu of collateral and therefore provide a higher yield to investors willing to purchase them). The problem here is that these tranches of ABS loans are not eligible under the existing TALF provisions, hence excluding a significant portion of originators from relief. It is likely that this will in turn lead to restricted credit access for millions of consumers.

Demand for unsecured consumer installment loans has expanded rapidly over the last 10 years, with volume more than doubling. The St. Louis Fed published an article stating that approximately 78% of consumers have utilized these loans in one form or another, most often for the purpose of refinancing existing debt. These loans also play a significant role in small business lending – which I can speak to anecdotally. Small business owners will often front initial start-up costs with personal loans from companies such as Prosper or Kabbage. Once they become “bankable” (i.e. they have a more stable track record operating as a business) they will seek to refinance these installment loans with a commercial loan at a lower rate.

Many fintechs fund their lending operations through the capital markets. They originate the aforementioned installment loans and then package them as investment-grade ABS products for sale to investors. As a result of the uncertainty stemming from the pandemic, the market for these riskier, higher yield ABS products has started to dry up. Since many of these fintech companies rely on the capital markets to fund their operations, the absence of prospective buyers for these tranches will force them to rely on their balance sheets to originate new loans, or halt lending for an undetermined period. Given the business model associated with most fintechs, the latter appears to be the more likely outcome. This will of course lead to a large swath of consumers being cut off from much needed credit.


Without access to reasonably priced credit, many consumers will be left without viable credit options. The alternative for many will be to accept credit on more expensive terms at a time when they will likely be unable to afford it. Unfortunately, given the dynamics of the pandemic, it is difficult to think of a viable solution to the aforementioned that wouldn’t have to come from TALF. This is especially true, in my opinion, given the issues we’ve seen with the roll out of PPP lending and individual stimulus checks.

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Federal Reserve Credit Facilities: An Overview

Photo by Random Sky on Unsplash

Two weeks ago the Federal Reserve announced a set of measures that largely mirrored the response to the 2008 financial crisis. Though nuanced in some respects, the credit facilities introduced by the Fed were generally in alignment with previous practices – albeit more aggressive than in crises past. Today all of that changed. The Fed announced an additional $2.3 trillion in loans and purchases in an attempt to stabilize a volatile and languishing economy. What makes today’s measures truly unprecedented, however, is that this is the first time in their 107 year history that the Fed agreed to purchase investment grade corporate bonds – effectively nationalizing the bond market.

With the blessing of the Treasury, the Fed has officially exhausted every conceivable measure at their disposal by extending credit to the most vulnerable verticals of the bond market – junk bonds, municipal bonds, and collateralized loan obligations (CLOs) are officially fair game. At this point, the only thing missing from the Fed’s “toolkit” is the extension of credit to purchase equities outright (but never say never). Though my opinion is clearly starting to bleed through, I will save my thoughts on the Fed’s response to the pandemic for another day. The objective of this post is to provide an overview of each credit facility that has been introduced by the Fed as of today. Considering the breadth of the existing measures, I consider it unlikely that the Fed will follow up with another announcement. For the time being, what’s presented below is an exhaustive summary of the Fed credit facilities. Highlights were taken directly from the Fed’s website.

Main Street Lending Program

  • The Fed will purchase 95% of the loan and the lender will retain 5% on its books – this is a full recourse loan with a tenor of 4 years.
  • Eligible Borrowers: businesses with up to 10,000 employees or up to $2.5 billion in 2019 annual revenues. Each eligible borrower must be a business that is created or organized in the United States with significant operations in and a majority of its employees based in the United States.
  • Loan Specifics:
    • 4 year maturity;
    • Amortization of principal and interest deferred for one year;
    • Adjustable rate of Secured Overnight Financing Rate (SOFR) +250-400 basis points;
    • Minimum loan size of $1 million;
    • Maximum loan size that is the lesser of (i) $150 million, (ii) 30% of the Eligible Borrower’s existing outstanding and committed but undrawn bank debt, or (iii) an amount that, when added to the Eligible Borrower’s existing outstanding and committed but undrawn debt, does not exceed six times the Eligible Borrower’s 2019 earnings before interest, taxes, depreciation, and amortization (“EBITDA”); and
    • Prepayment permitted without penalty.
  • There are a number of attestations that the Borrower must make to receive loan funds, but the crux of them focus on not utilizing funds to repay other loan balances. The Borrower must also make “reasonable” efforts to maintain its payroll/employees and agree to limits on compensation and stock buybacks.
  • Total Allocation: $600 billion and it will be seeded by $75 billion from the Treasury.
  • The program has not been finalized and the Fed will be receiving comments until April 16th. Details to come.

Municipal Liquidity Facility

  • The Fed will establish a Special Purpose Vehicle (SPV) to purchase municipal notes directly from eligible issuers.
  • Eligible Issuers:
    • U.S. states and the District of Columbia
    • U.S. cities with population over 1 million
    • U.S. counties with population over 2 million
  • Eligible Collateral:
    • Tax Anticipation Notes (TANs)
    • Tax and Revenue Anticipation Notes (TRANs)
    • Bond Anticipation Notes (BANs)
    • *All notes must mature in less than 2 years
  • Maximum Amount: the SPV can purchase is capped at 20% of the issuer’s fiscal year 2017 general revenue and utility revenue.
  • Pricing: will be based on the issuer’s bond rating (details forthcoming) and an origination fee of 10 basis points must be paid to participate in the facility.
  • Total Allocation: The SPV can purchase up to $500 billion in municipal notes and will be seeded with $35 billion from the Treasury. As it stands, the facility will sunset on September 30th, 2020.

Paycheck Protection Program Lending Facility

  • This facility exists to facilitate additional lending to small businesses under the PPP provision of the CARES Act. The Fed will take the PPP note as collateral, with no recourse to the borrower.
  • Eligible Borrowers: Depository institutions that are approved to originate PPP loans. The program will likely expand to include non-depository institutions participating in the program.
  • Rate and Fees: Extension of credit under the facility will be made at a rate of 35 basis points; there are no fees associated with this facility.
  • Collateral Valuation: PPP loans pledged as collateral to secure extensions of credit under the facility will be valued at the principal amount of the PPP loan.
  • Maturity Date: Credit extended by the Fed will have a maturity date equal to the PPP loan, but the maturity rate will be accelerated if the underlying asset goes into default and the eligible borrower sells the underlying asset to the SBA to realize the 100% SBA guarantee.
  • Regulatory Capital Requirements: The PPP loan will be assigned a risk weighting of 0% and PPP loans financed by this facility can be neutralized by banking organizations for leverage capital ratio requirements.

Term Asset-Backed Securities Loan Facility

  • The Term Asset-Backed Securities Loan Facility (TALF) is intended to help meet the credit needs of consumers and businesses by facilitating the issuance of asset-backed securities (ABS).
  • Under TALF, the Federal Reserve Bank of New York will commit to lend to an SPV on a recourse basis.
  • Eligible Borrowers: All U.S. companies that own eligible collateral and maintain an account relationship with a primary dealer are eligible to borrow under TALF.
  • Eligible Collateral: Must be an ABS where the underlying credit exposures are one of the following:
    • Auto loans and leases;
    • Student loans;
    • Credit card receivables (both consumer and corporate);
    • Equipment loans and leases;
    • Floorplan loans;
    • Insurance premium finance loans;
    • Certain small business loans that are guaranteed by the SBA;
    • Leveraged loans; or
    • Commercial Mortgages
    • *Eligible collateral will not include ABS that bear interest payments that step up or down to predetermined levels on specific dates. In addition, the underlying credit exposures of eligible collateral must not include exposures that are themselves cash ABS or synthetic ABS.
  • Term: Three years; non-recourse to borrower.
  • Pricing:
    • For CLOs, the interest rate will be 150 basis points over the SOFR;
    • For SBA Pool Certificates (7(a) Loans), the interest rate will be the top of the federal funds target range plus 75 basis points
    • For SBA Development Company Participation Certificates (504 Loans) the interest rate will be 75 basis points over the 3-year fed funds overnight index swap (OIS) rate.
    • For all other eligible ABS with underlying credit exposures that do not have a government guarantee, the interest rate will be 125 basis points over the 2-year OIS rate for securities with a weighted average life less than two years, or 125 basis points over the 3-year OIS rate for securities with a weighted average life of two years or greater. The pricing for other eligible ABS will be set forth in the detailed terms and conditions.
  • Fees: The SPV will assess an administrative fee equal to 10 basis points of the loan amount on the settlement date for collateral.
  • Total Allocation: The TALF SPV will initially make $100 billion of loans available and will be seeded with $10 billion from the Treasury.

Primary Market Corporate Credit Facility

  • This facility will serve as a funding backstop for corporate debt issued by eligible users. Under the facility, the Federal Reserve Bank of New York will commit to lend to an SPV on a recourse basis.
  • The SPV will purchase:
    • Qualifying bonds as the sole investor in a bond issuance;
    • Purchase portions of syndicated loans or bonds at issuance.
  • Collateral: The Reserve Bank will be secured by all assets of the SPV.
  • Eligible Assets:
    • Eligible corporate bonds as sole investor. Eligible corporate bonds must: be issued by an eligible issuer and have a maturity of 4 years or less.
    • Eligible syndicated loans and bonds purchased at issuance. Eligible syndicated loans and bonds must: be issued by an eligible issuer and have a maturity of 4 years or less. The facility may purchase no more than 25 percent of any loan syndication or bond issuance.
  • Eligible Issuers:
    • Must be a business that is created or organized in the U.S. or under the laws of the U.S.
    • Must be rated at least BBB-/Baa3 as of March 22, 2020 by a major nationally recognized statistical rating organization (NRSRO).
      • Issuers that were rated at least BBB-/Baa3 as of March 22, 2020, but are subsequently downgraded, must be rated at least BB-/Ba3 at the time the Facility makes a purchase.
    • The Issuer is not an insured depository institution or depository institution holding company.
    • The Issuer must satisfy conflicts-of-interest requirements as set forth by the CARES Act.
  • Leverage: Corporate bonds & loans can be levered 10:1, other assets can be levered 7:1.
  • Pricing:
    • Eligible corporate bonds: Pricing will be issuer specific, pursuant to market conditions, plus a 100 basis point facility fee.
    • Eligible syndicated loans and bonds: The facility will receive the same pricing as other syndicate members, plus a 100 basis point fee on the facility’s share of the syndication.
  • Total Allocation: Not to exceed $750 billion, seeded by $75 billion in Treasury funding.

Secondary Market Corporate Credit Facility

  • This program is very similar to the primary market corporate credit facility. The main difference here is that this facility will be used to purchase corporate bonds as well corporate bond portfolios issued on the secondary market.
  • Key differences are eligible asset classes, eligible sellers, and pricing. All other requisites remain the same as above.
  • Eligible Assets:
    • Eligible Individual Corporate Bonds: Must purchase bonds that were issued by an eligible issuers; have a maturity of 5 years or less; were sold to the facility by an eligible seller.
    • Eligible ETFs: The Facility also may purchase U.S.-listed ETFs whose investment objective is to provide broad exposure to the market for U.S. corporate bonds. The preponderance of ETF holdings will be of ETFs whose primary investment objective is exposure to U.S. investment-grade corporate bonds, and the remainder will be in ETFs whose primary investment objective is exposure to U.S. high-yield corporate bonds.
  • Eligible Seller: Each institution from which the facility purchases securities must be a business that is created or organized in the United States or under the laws of the United States with significant U.S. operations and a majority of U.S.-based employees. The institution also must satisfy the conflicts-of-interest requirements of section 4019 of the CARES Act.
  • Pricing: The facility will purchase eligible corporate bonds at fair market value in the secondary market. The facility will avoid purchasing shares of eligible ETFs when they trade at prices that materially exceed the estimated net asset value of the underlying portfolio.


This was a longer post than usual and certainly dense, but I hope you were able to find this information useful. These are the tools that will be utilized to stabilize credit markets in the U.S. and (hopefully) divert a deep recession as we navigate the coronavirus pandemic. As always, if you found this informative please like, subscribe, and share with your network.

Payment Protection Program Lending – Additional $250 Billion on the Way?

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Two weeks ago I published a blog on the SBA’s new loan program, the Payment Protection Program (PPP) that outlined eligibility, how to apply, and funding mechanism. The CARES Act allotted $349 billion to this program initially, but it appears that this may not have been enough. We’re less than two weeks into the new program and there are already concerns that funding will dry up – leaving several small business owners without relief. In line with these concerns, Treasury Secretary Mnuchin announced on Tuesday, April 7th via Twitter that he had asked for an additional $250 billion in funding for the program. Though the request appears justified, there have been significant issues with the rollout of this program. The existing issues with PPP and initial reactions from legislators, banks, and news outlets to additional funding will be discussed below.

A Rocky Start

According to an article published by Reuters on April 6th, there have been a myriad of issues with the administration of the PPP thus far. One major issue stems from ETRAN – the portal used to submit PPP loan packages to the SBA for approval. Some banks reported that the system crashed on Monday for hours, leaving them unable to process applications. Moreover, in addition to the clunky interface, there has also been some confusion around what documentation is required for the SBA to issue an authorization which has been a pain point for lenders.

This has effectively created a log jam, resulting in tension between all relevant stakeholders. Lenders are frustrated with incomplete and conflicting guidance from the Treasury/SBA which prohibits them from processing applications efficiently, this is turn leads to frustration from borrowers who feel lenders have been unresponsive or restrictive (some banks have restricted access to PPP loans to existing clients). In fact, the implementation of the existing program has been so mired with issued that the Fed had to once again step in and offer a facility to banks to move the process along. Specifically, the Fed has agreed to provide “term financing backed by PPP loans” which is a fancy way of saying the Fed will purchase PPP loans originated by banks concerned about the costs associated with originating/servicing the loans.

The Rational for Additional Funding

Despite the lackluster rollout, demand for PPP funding is high and continues to grow. Many small business owners are concerned that funding will run out before they can get access to relief. This appears to be a sentiment shared by Senators McConnell and Rubio. The former issued a statement on April 7th stating “it is quickly becoming clear that Congress will need to provide more funding or this crucial program may run dry. Nearly 10 million Americans filed for unemployment in just the last two weeks. Congress needs to act with speed and total focus to provide more money for this uncontroversial bipartisan program. The latter tweeted on April 6th that “the fear that PPP will run out of money is creating tremendous anxiety among small business.”

In addition to concerns from legislators and small business owners, banks have weighed in to express concerns about the existing allocation for the program. Bank of America and Wells Fargo have reported a combined $42.6 billion in applications – more than 10% of the total allocation over the course of five days. This is an issue that goes beyond large corporate banks, several community banks have also expressed technical and logistical issues with the program so far, issues that are compounded by increasing demand from small business owners. Moreover, small businesses have started to complain about access to capital. Many lenders are backed up with thousands of applications and have started to decline new applicants, which will ultimately accelerate the need for additional funding or incentives for banks to process these loans – likely both.


Though more funding appears to be justified, it is my opinion that the real issues lie in the administration of the program. If lenders and the Treasury/SBA cannot get on the same page quickly, implementation of the program will be underwhelming. Despite the best efforts of Congress and the Fed, if the program is not accessible to Main Street than money will not flow to those who need it the most, this will in return result in a failure of the program. I believe efforts to provide additional funding to the initial PPP allocation should also include clear guidance from federal administrators to lenders to ensure the program can be implemented more efficiently moving forward.

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