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On March 23, in response to the turmoil, the Federal Government announced the establishment of the Primary Corporate Credit Facility (PMCCF) to provide capital to struggling corporations by granting loans or purchasing new bond issuance. Simultaneously, the Secondary Market Credit Facility (SMCCF) was established to provide liquidity for outstanding corporate bonds trading in the secondary market. The combined size of the two credit facilities will be upwards of $750 billion. The facilities launched by the Fed have been critical to restoring order in corporate bond market overall. There is concern that investors will continue to invest in riskier assets due to Fed support (so called “moral hazard”) and ignore the underlying fundamentals of the issuer, but the severity of the market gridlock required action. The facilities have a “soft” closing date of September 30 and if not renewed or expanded this may pose some additional risk to the credit market when they expire.

The PMCCF is a lending facility open to investment grade companies offering bridge loans of up to four years. The Federal Reserve will lend to a special purpose vehicle that will make loans to eligible PMCCF companies and can also participate in new bond issuance. The SMCCF will purchase secondary market corporate bonds issued by investment grade companies and US listed exchange-traded funds (ETFs) whose investment objective is to provide broad exposure to US investment grade corporate bonds issued by companies that are or were investment grade rated as of March 22, and that remain rated at least BB-/Ba3 at the time of purchase. The preponderance of ETF holdings will consist of those mainly exposed to US investment grade corporate bonds, with the remainder largely exposed to US high yield corporate bonds. Prior to the announcement of the support programs, Morningstar1 noted that market volatility caused many ETFs to trade at extreme discounts to their net asset values (NAV). For example, during the week of March 9, the Vanguard Total Bond Market ETF (BND) traded at a discount to its NAV of 6.24%. Many bond ETFs have since rebounded as investor inflows returned.

At the time of the announcement, credit spreads as measured on the ICE BofA US Corporate Bond Index reached a multi-year high of 397 basis points. As the chart illustrates, spreads have subsequently declined to 218 basis points, even though the facility has yet to make any purchases. This downward movement in spreads is positive as it lowers the cost of capital for companies issuing debt as well as generating a positive return for investors who purchased the debt at higher spread levels.

To qualify as an eligible issuer, the issuer must satisfy certain conditions. First, the issuer must be a business that is created or organized in the United States or under the laws of the United States with significant operations in and a majority of its employees based in the United States. Second, the issuer must have held an investment grade rating as of March 22, by a major nationally recognized statistical rating organization (NRSRO). An issuer that was investment grade as of March 22, but was subsequently downgraded, must be rated at least BB-/Ba3 as of the date on which the PMCCF or SMCCF makes a purchase. Third, the issuer must not be an insured depository institution or depository institution holding company, as such terms are defined in the Dodd-Frank Act. Finally, the issuer must not have received specific support pursuant to the CARES Act.

Our fixed income process focuses on individual bonds that are approved by our independent research process. Favorably, many of the corporate bonds already held in client portfolios meet the criteria of the government programs and have therefore seen price improvement as a result.  We have increased our purchases of investment grade companies with recent additions including Oracle, Home Depot, Target, Visa, AbbVie and Coca-Cola. Additionally, we are researching other areas of the bond market for opportunistic investment and have been doing more buying than selling during recent weeks.
1Morningstar “Navigating the ETF Discounts and Premiums During Turbulent Times”, March 20, 2020