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.”
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