March 18, 2020
The Federal Reserve stepped in to help the commercial paper market and overnight lending to investment banks.

Executive Summary:

The Federal Reserve (Fed) rolled out two more tools, first utilized during the Great Recession, to respond to the rapidly evolving coronavirus (COVID-19) outbreak. While such moves will not stop a recession, they can hasten recovery and restore smooth market functioning within the US fixed income arena and short-term lending, which is critical to the global economy and could help prevent further damage.

What Happened

On March 17, the Fed restarted the Commercial Paper Funding Facility (CPFF) and the Primary Dealer Credit Facility (PDCF), using the emergency powers under Section 13(3) of the Federal Reserve Act, with approval of the Treasury Secretary.

The CPFF will purchase top-tier rated unsecured and asset-backed commercial paper directly from eligible companies. Commercial paper is a short-term negotiable note maturing in less than 9 months (270 days or less) and issued by industrial, commercial, and financial companies. It is used to fund short-term operational needs of large businesses, such as accounts payable and inventories, while firms await payment.

The PDCF will offer overnight and term funding with maturities up to 90 days to primary dealers, which is the technical name for investment banks. The Fed committed to keeping the PDCF in place for at least six months using the discount rate, which is currently 0.25%. Credit extended to primary dealers under this facility may be collateralized by various investment grade debt securities, including commercial paper and municipal bonds, and a broad range of equity securities.

Background on Both Programs

During the Great Recession, the CPFF and PDCF were temporary programs chiefly used for a year or two. These, along with four other targeted funding facilities, were collectively known as the Fed’s alphabet soup. More importantly, their use during the Great Recession is illustrative of just how effective these programs can be in supporting proper market function during times of market stress. 

The commercial paper funding facility was established in late October 2008. In January 2009, the CPFF’s total outstanding value peaked at $350 billion in a market estimated around $1.5 trillion in size. The CPFF was closed to new lending in February 2010, and the remaining holdings matured in April 2010. All CPFF loans were repaid in full, and the program was ended in August 2010.

The bulk of the CPFF was used over a 10-month span during the deepest period of the Great Recession.

The primary dealer credit facility was established on March 16, 2008, after the collapse of Bear Stearns. It was needed since investment banks are not eligible for overnight funding directly from the Fed’s so-called discount window.

It was predominantly used during two episodes. The first big chunk was about $40 billion, most of which was direct to Bear Stearns, and approached zero within nearly four months. There was a second big spike to almost $150 billion several months later when Lehman Brothers began to wobble in mid-September. The number of firms utilizing the PDCF was never more than a dozen, and the total outstanding tapered sharply within three months and was zero in eight months. Similar to the CPFF, all loans extended under the PDCF were repaid in full with interest, and it was closed on February 1, 2010.

The PDCF was utilized in two episodes for just 15 months and by roughly a dozen firms at its peak.

Our Take

The sum of the Fed’s actions over the past 10 days amounts to a staggering level of support for the US financial system and its fixed income markets. These programs clearly demonstrate the Fed is doing whatever it takes to combat the fallout from the virus outbreak.

The stress in short-term funding markets and fixed income’s liquidity levels demanded this type of intervention—and may require more action to ensure that these markets function properly. For instance, additional asset purchases, expanded repo operations, and the CPFF appear to be helping restore some of the liquidity missing in the US fixed income markets. Last week’s sell-at-any-cost of US Treasuries due to drained liquidity appears to have subsided. However, credit spreads in corporate and municipal bonds remain very elevated, which is still causing pricing dislocations.

Moreover, the Fed’s swift and decisive actions were necessary, and we believe they have influenced other global central banks to unfurl similarly impactful monetary policy actions.

As liquidity and trading move towards more normalized levels in the US Treasury market, this should eventually help ease pressures on other areas in fixed income. Given uncertainty surrounding the impact and duration of the COVID-19 outbreak on the global economy, we suspect credit spreads will remain high.

Bottom Line

The Fed’s aggressive monetary policy measures—coupled with the anticipated fiscal stimulus expected from Congress and the White House—are necessary to address the immediate stresses in the financial system and alleviate the virus’s economic damage until the coronavirus is contained. Such moves cannot stop a recession, but could hasten the recovery and help restore smoother market functioning within US fixed income and short-term lending, which play critical roles in the global economy.

Disclosures

This material was provided by SunTrust Private Wealth Management for use by BB&T Wealth.

Advisory managed account programs entail risks, including possible loss of principal and may not be suitable for all investors. Please speak to your advisor to request a firm brochure which includes program details, including risks, fees and expenses.

SunTrust Private Wealth Management is a marketing name used by Truist Financial Corporation and the following affiliates: Banking products and services, including loans and deposit accounts, are provided by SunTrust Bank and Branch Banking and Trust Company, both now Truist Bank, Member FDIC. Trust and investment management services are provided by SunTrust Bank and Branch Banking and Trust Company, both now Truist Bank and SunTrust Delaware Trust Company. Securities, brokerage accounts and /or insurance (including annuities) are offered by SunTrust Investment Services, Inc., BB&T Securities, LLC, and P.J. Robb Variable Corp., which are SEC registered broker-dealers, members FINRA, SIPC, and a licensed insurance agency where applicable. Investment advisory services are offered by SunTrust Advisory Services, Inc., GFO Advisory Services, LLC, BB&T Securities, LLC, Sterling Capital Management, LLC, Precept Advisory Group, LLC, and BB&T Institutional Investment Advisors, Inc., each SEC registered investment advisers.  BB&T Sterling Advisors, BB&T Investments and BB&T Scott & Stringfellow are divisions of BB&T Securities, LLC. Mutual fund products are advised by Sterling Capital Management, LLC.

While this information is believed to be accurate, SunTrust Banks, Inc., now Truist Financial Corporation, including its affiliates, does not guarantee the accuracy, completeness or timeliness of, or otherwise endorse these analyses or market data.

The opinions and information contained herein have been obtained or derived from sources believed to be reliable, but Truist Financial Corporation makes no representation or guarantee as to their timeliness, accuracy or completeness or for their fitness for any particular purpose. The information contained herein does not purport to be a complete analysis of any security, company, or industry involved.  This material is not to be construed as an offer to sell or a solicitation of an offer to buy any security.

Opinions and information expressed herein are subject to change without notice. STIS and/or its affiliates, including your Advisor, may have issued materials that are inconsistent with or may reach different conclusions than those represented in this commentary, and all opinions and information are believed to be reflective of judgments and opinions as of the date that material was originally published.  STIS is under no obligation to ensure that other materials are brought to the attention of any recipient of this commentary. 

Truist personnel are not permitted to give legal or tax advice.

Investments involve risk and an investor may incur either profits or losses. Past performance should not be taken as an indication or guarantee of future performance.

STIS/STAS shall accept no liability for any loss arising from the use of this material, nor shall STIS/STAS treat any recipient of this material as a customer or client simply by virtue of the receipt of this material.

The information herein is for persons residing in the United States of America only and is not intended for any person in any other jurisdiction.

Investors may be prohibited in certain states from purchasing some over-the-counter securities mentioned herein.

The information contained in this material is produced and copyrighted by Truist Financial Corporation and any unauthorized use, duplication, redistribution or disclosure is prohibited by law.  

STIS/STAS’s officers, employees, agents and/or affiliates may have positions in securities, options, rights, or warrants mentioned or discussed in this material.

Asset classes are represented by the following indexes. An investment cannot be made directly into an index.

S&P 500 Index is comprised of 500 widely-held securities considered to be representative of the stock market in general.

©2020 Truist Financial Corporation. BB&T, SunTrust®, the SunTrust logo, and Truist are service marks of Truist Financial Corporation. All rights reserved

CN2020 0669EXP12-2020