Specifics of the Fed’s Actions
This morning the Fed, with Treasury’s support, announced a $2.3T set of programs to further support the markets. Additionally, by teaming with the Treasury, the Fed funding programs accept credit risk which is a first for them. Key new program points announced by the Fed this morning:
- PPPLF (Paycheck Protection Program Liquidity Facility). The Fed will fund the PPP program by using as collateral loans in the PPP program at face value. (These loans stay on the bank’s balance sheet, but funding will come from the Fed. Hence, PPP loans leverage the balance sheet, but do not add liquidity or credit issues.)
- Main Street Lending Program support by purchasing $600B in loans. The Fed is offering funding for four-year loans to mid-sized businesses with principal and interest payments deferred for one year. Banks will retain 5% of these loans, but risk is shared on a pari passu basis (i.e., the bank’s 5% is not in a first loss position as percentage risk is shared equally between the bank and Treasury). The Treasury is providing $75B in equity to the facility as credit risk support
- PMCCF, SMCCF, TALF programs are expanded to $850B with $85B credit support from the Treasury. TALF collateral will be expanded to include AAA-rated CMBS and newly issued CLOs. These facilities also allow for companies that were investment grade prior to March 22nd but are now below investment grade (“fallen angels”) to participate in the program. This is designed to backstop the high yield funding market in the form of an SPV bypassing the banks
- Establishing a Municipal Liquidity Facility of $500B supported by $35B of credit support from the Treasury. This bypasses the banks by creating an SPV to directly fund the municipals
- Finally, in Chairman Powell’s statement and interview this morning, he indicated that the Fed would continue to monitor the market and act as appropriate (i.e., there are more kitchen sinks to come if needed).
Potential Implications for ALM Managers
For now, the Fed has taken financial market liquidity off the table. Virtually every dimension of the financial markets has some form of Fed/Treasury support. This includes the banks which started in generally strong liquidity positions to begin with and which now have multiple Fed backstops to cover potential liquidity issues.
From an ALM management perspective, there are three areas of focus which these and the prior programs should drive:
- Monitoring Fed/Treasury/SBA execution risk. Early warning indicators dashboards should include changes in deposit account levels and line usage at the account levels to watch for stress in consumer and small business customer groups particularly for financial stresses overwhelming the support being delivered which have liquidity and impending credit risk implications. Issues will appear here before showing up on traditional credit risk monitors
- Adding products/product attributes which align with the new programs. This is specific to the PPP and Main Street lending programs which carry substantial Fed/Treasury liquidity and credit risk support. There are matched funding issues and credit guarantees embedded in the loans, but also capital allocation implications which should be considered for measuring capital leverage
- Developing approaches to carry loans where interest and principal are being foregone for set periods of time. Bankers are foregoing or delaying some principal and interest payments which could wreak havoc on credit risk and cashflow models. Modelers will want to find ways to incorporate these features into loans so that accruals and cash flows are captured correctly.
Based on commentary coming out of D.C., we should expect additional fiscal and monetary actions which are likely to have implications for bank balance sheet management.