By James A. Betzig, Dana Mascalo, Lise Robinson, W. Michael Smiley, Eric Passeri, and Matthew Gallagher
TrinityPoint Wealth
On April 9, Jerome Powell and the Federal Reserve announced $2.3 trillion in new programs to support the US economy. These programs add to existing measures that were announced by the Fed in March and those created by Congress under the CARES Act. Most notably, the Fed announced they would begin buying corporate junk bonds; create a Main Street Lending Program that will provide up to $600 billion to medium-sized businesses, and; create a municipal liquidity facility that will provide up to $500 billion to states and municipalities.
Totaling $1.5 trillion, these initiatives included a plan to buy investment-grade commercial bonds, the purchase of commercial mortgage-backed securities, and the creation of three new credit facilities, according to CNN.
While these efforts did provide much-needed stability, weekly unemployment figures have continued to paint a bleak picture: the Labor Department reported that 6.6 million new unemployment applications were received the week ending April 4, and this was on the heels of 6.9 million claims and 3.3 million claims for the weeks ending March 28 and March 21, respectively.
It was within this context that on April 9 Federal Reserve Chair Jerome Powell announced a second round of programs and measures totaling $2.3 trillion to support the U.S. economy.
The Fed enters the corporate junk bond market
Most surprising was the Fed’s decision to begin purchasing high-yield (or “junk”) corporate bonds, expanding on their move in late March to purchase investment-grade corporate bonds and bond funds. In our view, this shows the Fed’s willingness to take unprecedented steps to support the economy during this pandemic.
The Fed’s corporate bond purchases will be made in the primary market, where bonds are purchased directly from the issuing company, and in the secondary market, where bonds are resold on an exchange. Both the primary and secondary markets have suffered a liquidity crisis in recent weeks as the number of sellers has vastly outnumbered buyers. This announcement means that the Fed will be a buyer going forward.
Fallen angels
The Fed’s decision to enter the high-yield corporate bond market is specifically designed to support “fallen angels”: companies that have recently lost their investment-grade rating and are now considered junk.
In order for a company to qualify as a fallen angel, the company must have had a rating of at least BBB-/Baa3 by two or more credit agencies as of March 22, and their current rating cannot be lower than BB-/Ba3. Notable companies that meet these criteria are Ford Motor Company, Macy’s, and Kraft Heinz.
The Fed entering the high-yield portion of the corporate bond market will likely create fixed-income opportunities in the coming weeks and months. As a result, our investment committee is following this decision closely in order to make strategic adjustments to client portfolios.
New loans for small and medium-sized businesses
The Fed also announced that $600 billion worth of new loans will be available to small and midsized businesses through the Main Street Lending Program. These funds will be distributed through two different lending facilities, and this new program is separate from the Payroll Protection Program administered by the Small Business Administration.
Program details and who can apply
These loans will be accessible to businesses with up to 10,000 employees or up to $2.5 billion in revenue in 2019. Loan amounts will generally be in the $1 to $25 million range, and loan terms are for four years with interest payments deferred for the first year. It looks like the rate on these loans will be the Fed’s current overnight rate (0.01 percent for now) plus 2.5 percent to 4 percent.
As with the PPP, the distribution of these loans will be handled by major banks. Each bank must retain a 5 percent interest in each issued loan, and the Main Street Lending Program facility will hold the remaining balance. The Treasury Department will provide a “backstop” of $75 billion to manage losses on issued loans.
We know this is an extremely difficult time for business owners, many of whom have had to make tough decisions in recent weeks. We’ve been inspired by how our business owner clients have responded and adjusted to this crisis. Just one local example, Thermaxx Jackets, recently pivoted to making personal protective equipment gowns for frontline medical providers.
In recent weeks, we’ve helped a number of our business-owner clients navigate the PPP. Depending on the size and scope of a company’s operation, this announcement from the Fed could provide some businesses with additional support.
Lending for state and local governments
In an effort to support state and local governments that have been hit hard financially by the COVID-19 pandemic, the Fed also announced it will make $500 billion in low-interest loans available to municipalities. As with the Main Street Lending Program, the Treasury will “backstop” $35 billion on loans issued to municipalities.
A historic initiative
While the Fed has purchased treasuries in the past, it has always been hesitant to enter the municipal bond market. Unlike the US Treasury, which can effectively create money to satisfy its outstanding debts, states and local governments do not have this power.
The Treasury can also carry a fiscal deficit if necessary. The vast majority of state and local governments, on the other hand, have a legal and/or constitutional requirement to keep a balanced budget. This lack of flexibility on the issuer side increases the Fed’s potential risk as a prospective bondholder. Therefore, for now, it appears that the Fed will primarily limit its municipal bond purchases to short-term debt.
Final thoughts
These are undoubtedly uncertain times. Now more than ever, our mission is to be a consistent, steady, and guiding force for your financial life. Whether you have immediate concerns about your business, or you need a little help with your long-term wealth management strategy, TrinityPoint Wealth is here to support your well-being. We are all in this together.
The writers are members of TrinityPoint Wealth. James A. Betzig is a partner and CEO. Dana Mascalo is a managing partner and senior wealth advisor. Lise Robinson is a partner and senior wealth advisor. W. Michael Smiley is a managing partner. Eric Passeri is an investment officer. Matthew Gallagher is a partner and head of business development. TrinityPoint Wealth does not provide legal or tax advice, and nothing contained in these materials should be taken as legal or tax advice.