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Fed's New Facility Will Buy Junk Bonds With 7-1 Leverage

Today, the Fed announced the terms of its new bond facility. In reality it's nothing but an asset price support mechanism.
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Fed will Buy Junk Bonds With 7-1 Leverage

Moral Hazard

With highly questionable legality on top of a 100% certain moral hazard, here are the details of the Fed's new Secondary Market Corporate Credit Facility

Credit Facility Terms

  • The issuer was rated at least BBB-/Baa3 as of March 22, 2020, by a major nationally recognized  statistical rating organization (“NRSRO”). If rated by multiple major NRSROs, the issuer must be rated at least BBB-/Baa3 by two or more NRSROs as of March 22, 2020. 
  • An issuer that was rated at least BBB-/Baa3 as of March 22, 2020, but was subsequently downgraded, must be rated at least BB-/Ba3 as of the date on which the Facility makes a purchase. If rated by multiple major NRSROs, such an issuer must be rated at least BB-/Ba3 by two or more NRSROs at the time the Facility makes a purchase.
  • The issuer has not received specific support pursuant to the CARES Act or any subsequent federal legislation and must satisfy the conflicts of interest requirements of section 4019 of the CARES Act.

Leverage

  • The Facility will leverage the Treasury equity at 10 to 1 when acquiring corporate bonds of issuers  that are investment grade at the time of purchase.
  • The Facility will leverage its equity at 7 to 1 when acquiring corporate bonds of issuers that are rated below investment grade at the time of purchase and in a range between 3 to 1 and 7 to 1, depending on risk, when acquiring any other type of eligible asset.

Unknown Duration

  • The Facility will cease purchasing eligible individual corporate bonds, eligible broad  market index bonds, and eligible ETFs no later than September 30, 2020, unless the Facility is extended by the Board of Governors of the Federal Reserve System and the Treasury Department.
  • The Reserve Bank will continue to fund the Facility after such date until the Facility’s holdings either mature or are sold.

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Leveraged Asset Support System

I think we need a new name to properly explain what it really is: an asset price support mechanism.

Not only is the facility a legally questionable moral hazard, it is also nothing but an asset prices support system that keeps zombie corporations alive.   

Simply put, it's a Leveraged ASS Deal with an unknown duration.

Mish

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