The US Federal Reserve has not yet spent a cent on corporate bonds but the possibility that it might has nonetheless sparked a massive turnaround in US credit markets.
The positive sentiment sparked by the Fed's announcement of primary and secondary corporate bond purchase programmes on March 23 has helped bring more than US$263bn of new issuance to the US investment-grade bond market since then, according to IFR data.
And support for corporate bonds continued on Friday as the Fed released expanded criteria for the primary and secondary credit facilities to include companies that have been downgraded to Double B since March 22.
The announcement sent spreads racing tighter in the secondary market, especially for credits such as US automaker Ford, which was downgraded to high-yield in recent weeks and is now eligible to receive funding from the Fed.
“This is similar to when Mario Draghi said ‘whatever it takes’. This time it’s ‘whatever it’s rated',” said David Knutson, head of credit research at Schroders. “You do not fight the Fed; you’ll lose a lot of money doing that.”
Market participants have for weeks wondered whether the Fed would buy bonds directly as the sole buyer or whether it would participate in the syndication of bonds in the public market like a regular investor.
It turns out, it will do both.
The primary facility – through the Fed’s purchasing partner BlackRock – may buy no more than 25% of any publicly syndicated primary bond issuance and all eligible bonds must have a maturity of four years or less, according to the Friday release.
But in order to take advantage of the programme, issuers will have to pay a 100bp fee, which means the primary programme will be a worst-case scenario-play for only the most distressed issuers that cannot access the market otherwise.
"If you can access the public markets and it's not punitive, that would be your preference," said Jeff Glenn, co-head of portfolio management at Breckinridge Capital Advisors.
And credit markets are very open as average new issue concessions came in at just 1.9bp last week and order books had average subscription levels of 7.6 times, according to a BMO Capital Markets report.
“Nobody wants to go into that [the Fed’s primary credit facility] if they can avoid it," one investor said, noting that even struggling cruise liner Carnival chose to access public markets with an 11.5% coupon rather than wait for the Fed's primary programme to start.
NEGATIVE NEWS
Yet there is still a sense that the Fed's backstop is needed in case more negative news shuts the market down to new issuance again.
Concerns of a prolonged credit crunch are evident when high quality names are taking size out of the market to shore up already plump cash reserves.
Banks are encouraging issuers not to draw down credit lines, yet nearly 100 companies have done just that since mid-March, according to a Bank of America research note.
Thirteen of them – including Dell, McDonald's and Anheuser-Busch InBev – have double-dipped by taking out debt from the bond market while drawing on credit lines.
"People are thinking, depending on how this plays out, there may be no new issue markets in a month's time," the investor said.
"The lesson they've learned from the past is, when you can get funding take it and worry about the cost later."
SECONDARY BUYING
More so than the potential of purchases in the primary market, it is the promise of Fed bond buying in secondary trading that has catalysed issuance, even though the secondary purchase programme has also not yet kicked off.
In a blow to banks, the Fed clarified on Friday that it will not purchase individual bank bonds. However, much of the purchases will be made in ETFs that naturally have bank exposure providing further support for the space, according to Dan Bruzzo, managing director of bank finance at Amherst Pierpont Securities.
"It's an easier way for the government to lend support to credit without exposing itself to all the idiosyncrasies of buying individual bonds," Bruzzo said.
"They probably view it as being dually beneficial of supporting credit and also bolstering liquidity in the system."