New Fed Facilities Will Help High Yield Debt Less Than You Think

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The Federal Reserve’s Main Street loan facilities are intended for businesses with fewer than 10,000 employees.

Photograph by Chip Somodevilla / Getty Images

While the Federal Reserve’s plan to buy corporate debt may not be the high yield bond blessing investors wanted, low-rated borrowers should get additional support from a different program. of the central bank.

Specifically, the Fed’s new Main Street lending facilities could allow banks to lend more to low-rated borrowers. The two facilities, one for new loans and the other for increasing existing loans, are intended for companies with less than 10,000 employees and less than $ 2.5 billion in annual turnover, a description that matches many low-rated companies.

These facilities are “arguably the backbone of support” for businesses rated as garbage, not the corporate debt buying program, he wrote.

UBS

strategist Matthew Mish in a Monday note.

Under the Main Street facilities, banks will be able to sell the Fed up to 95% of loans to midsize businesses that meet certain criteria. For example, loans must have a term of four years and be made at an interest rate 2.5 to 4 percentage points higher than the Secured Overnight Financing Rate, which the United States has chosen to replace the London Interbank Offered. Rate, or Libor. (Last week that would have meant an interest rate of between 2.51% and 4.01%, for example.) The Fed said it would buy back up to $ 600 billion of those loans.

According to Bank of America, about 45% of borrowers from publicly traded companies are eligible for Main Street loan programs. But that doesn’t mean the Fed will support nearly half of the junk-bond market.

On the one hand, the outstanding debt of these borrowers only represents about 30% of the market, according to the bank’s estimates. And that 30% figure isn’t very helpful anyway, as companies aren’t allowed to pay off existing loan balances with their money, except for mandatory principal payments on maturing debt. during the term of the loan.

This means that unlike the central bank’s other corporate debt program, companies will not be able to refinance themselves with liquidity backed by the Fed. Thus, the Main Street facility may be the most attractive to distressed borrowers who need loans for mandatory capital payments, especially because the program also prohibits companies from paying dividends or buying back shares for a period of time. year after repayment of their loans.

And the two Main Street loan programs have size and leverage limits: loans cannot exceed $ 150 million, nor can they carry borrowers’ debt burdens above. four or six times last year’s profit before interest, taxes, depreciation and amortization or Ebitda. Borrowers must also commit to making “reasonable efforts” to maintain their payroll.

Because of all of these rules, high-yield borrowers who take advantage of the Main Street program will likely be limited to those who are in trouble, with debt yields more than 10 percentage points higher than T-bills, according to UBS.

The bank estimates that troubled listed distressed borrowers who are eligible for the Fed’s Main Street facilities have $ 300 billion outstanding. While it’s not an overwhelming sum, it’s still a decent portion of the nearly $ 3 trillion in high yield bonds and loans outstanding, according to LCD.

But this is where another important restriction comes in. Insolvent borrowers – those with asset values ​​well below the value of their debt – will also not be able to use the Fed’s facilities, as UBS points out.

Without a thorough credit analysis and some lucky guesswork, it’s unclear how many of those $ 300 billion in borrowers will remain solvent throughout the closure and recovery from the novel coronavirus. The global pandemic is expected to cause an unprecedented slowdown in economic activity and has prompted most banks to cut their growth estimates for this year.

So, when it comes to high yield markets, at least, this “critical pillar” can end up being a bit shaky.

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