The Federal Reserve Board has rushed to create a large menagerie of funds that will try to keep deals happening in U.S. investment markets, by buying certain types of assets, such as commercial paper, and investment-grade corporate bonds.
Critics, including Jim Bianco, say that the Fed is exceeding its statutory authority and, in effect, helping the U.S. Treasury nationalize large parts of the financial markets.
Supporters say the Fed is simply nursing the investment markets through the upheaval caused by the effort to control the COVID-19 pandemic.
Shachar Gonen and other analysts at Moody’s Investors Service predict that, for U.S. life insurers, the effect of one of the new funds, the Secondary Market Corporate Credit Facility (SMCCF), will be to help keep corporate bond downgrades from hurting the insurers’ own finances.
A bond is a security that a company or organization uses to borrow money from investors.
The SMCCF will buy investment-grade bonds that are already somewhere in the “secondary market,” meaning that an insurer, pension plan, university endowment, mutual fund or other investors owns the bond.
U.S. life insurers use earnings on large investment portfolios to support their obligations to insurance policyholders and annuity contract holders.
Life insurers ended 2018 with $4.2 trillion in cash and invested assets, including about $3 trillion in bonds, and more than $2.8 trillion in bonds issued by “investment-grade” corporations, or corporations with high credit ratings.
“However, U.S. life insurance companies have become more susceptible to negative ratings migration over the past few years,” the Moody’s analysts write in a new commentary about the impact of the SMCCF
Even though most bonds in U.S. life insurers’ are investment-grade bonds, about 34% of those investment-grade bonds are just above the line between investment grade and below investment grade, the analysts write in the commentary, which is posted behind a paywall.
A “below investment grade bond,” or junk bond, is a bond issued by a company that looks as if it could have trouble making its payments.
If COVID-19 disruption continues to hurt the economy, that could weaken some investment-grade corporate bond issuers and push those issuers down into the junk bond issuer category.
Under states’ insurance company capital rules, life insurers need to add capital, for “risk-based capital charges,” for any junk bonds they hold, to compensate for the risk that the junk bond issuers will fail to pay their bills.
By pumping money into the corporate bond market, the SMCCF “would support corporate bond market prices and provide additional liquidity to those corporate bond holdings,” the analysts write.
By helping to keep investment-grade corporate bond issuers in the investment-grade category, the SMCCF should help reduce the risk that life insurers will end up with a much higher level of junk bonds, and help reduce the risk that life insurers will face higher risk-based capital charges, the analysts write.
— Read Could the Fed’s Cure Be Worse Than the Disease?, on ThinkAdvisor.