(Reuters) – A funding backstop the U.S. Federal Reserve launched on Tuesday aims to help address liquidity problems that have lingered in the coronavirus-roiled commercial paper market, but some analysts say the high borrowing costs may limit participation.
The Commercial Paper Funding Facility’s (CPFF) special purpose vehicle purchases higher rated, three-month unsecured and asset-backed paper from eligible bank, corporate, special-purpose entity and municipal issuers using financing from the New York Federal Reserve. The vehicle, which was announced on March 17, began making purchases on Tuesday according to the New York Fed.
The program is similar to an operation used during the 2008 financial crisis, in which the central bank acts as a lender of last resort for companies otherwise unable to borrow in the short-term market.
“Just knowing it is available has helped to calm the market,” said Kevin Giddis, head of fixed income at Raymond James.
Short-term credit markets had come under strain as investors worried that companies hit by efforts to slow the spread of the virus would not be able to repay their IOUs. That spurred the Fed to take steps aimed at thawing out markets frozen by spiking lending rates.
Deborah Cunningham, chief investment officer at Federated Hermes in Pittsburgh, said the move will provide a backstop for the market.
“I don’t know that it’s going to get a whole lot of utilization,” she said. “Having said that, I think it’s good that it’s there and it adds sort of a floor if spreads started to get too wide for whatever reason.”
Cunningham added that issuers may not like the fee they are required to pay to participate in the program. The 10-basis-point “facility fee” is based on the maximum amount of an issuer’s commercial paper that the special purpose vehicle may own.
The Federal Reserve said on March 17 that each user must pay a fee of 10 basis points of the maximum amount outstanding over last year. The daily CPFF rates borrowers paid on Tuesday were 1.18% for high-grade A1/P1 debt, and 2.08% for lower-grade A2/P2 debt.
“Had the Fed wanted to lower the prices of the CPFF and the Money Market Mutual Fund Liquidity Facility (MMLF), it would have done so by now,” wrote Zoltan Poszar, money market analyst at Credit Suisse.
Through the MMLF the Fed lends money to financial institutions to buy assets from money market funds, which are among the largest holders of commercial paper.
The primary reason for the high price, Poszar said, is that lower-priced facilities – including the Fed’s Primary Dealer Credit Facility, which provides overnight loans to primary dealers, and the discount window, which makes short-term loans to banks facing liquidity crises – are secured, while the CPFF is unsecured.
“The Fed is using their price to mitigate the credit risk of buying unsecured bank debt.”
The facility is funded with $10 billion in equity from the U.S. Treasury, which the Fed is expected to leverage as much as 10 times should demand warrant.
Companies rely on commercial paper as a source of short-term cash for payrolls, inventory and accounts payable as well as unanticipated funding needs.
Since the introduction of its facility, rates across maturities for both high-grade and lower-grade paper have fallen.
Earlier this month, the New York Fed announced it hired Pacific Investment Management Company (PIMCO) to serve as investment manager for the facility and retained State Street Bank & Trust Company to be the custodian and accounting administrator.
(Reporting By Karen Pierog in Chicago. Additional reporting by Kate Duguid and Jonnelle Marte in New York; editing by Megan Davies, Shri Navaratnam and Cynthia Osterman)
