A chart showing that a lot of corporate securities deals were failing from about March 18 to April 15 (Credit: Federal Reserve Bank of New York)

The Federal Reserve Bank of New York is starting to try to keep the U.S. corporate bond market moving, by buying high-grade corporate bonds that are already on the market when no one else will buy the bonds.

The bank said Monday that it has put $37.5 billion into “special purpose vehicle,” or investment fund, that will fuel a new Secondary Market Corporate Credit Facility SMCCF and a new Primary Market Corporate Credit Facility (PMCCF).

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The PMCCF will help organizations with high credit ratings borrow money, by issuing bonds, when finding buyers for new bond issues is difficult.

The SMCCF will be buying high-quality corporate bonds, and shares of U.S.-listed exchange traded funds (ETFs) that invest mainly in corporate bonds, that are already on the market, when the holders of those bonds have a hard time finding buyers.

The New York Fed established the PMCCF and the SMCCF, with help from BlackRock, in March, after COVID-19-related turmoil began to freeze the bond market.

The bank plans to add a second infusion of $37.5 billion into the SMCCF later.

Figures from the New York Fed show that, between mid-March and early April, the turmoil caused the volume of corporate securities deal transaction failures to double.

Life Insurers care deeply about the health of the secondary corporate bond market, because they have about $2.8 trillion of their $4.2 trillion in assets invested in corporate bonds.

Life insurance policies and annuities are, mainly, consumer-friendly financial sausages stuffed with corporate bonds, and derivatives used to keep the corporate bond stuffing fresh and tasty.

For life insurers, one risk associated with holding bonds is that the issuers could fail.

Another risk is that rating agencies could lower the bond isuers’ credit ratings.

State insurance regulators try to encourage life insurers to hold the safest bonds possible. They base the amount of bond value a life insurer can include in its risk-based capital ratio, or basic financial health indicator, on a bond’s rating.

Steve Zabel, the chief financial officer at Unum Group, said last week, during a conference call the company held to go over first-quarter results with securities analysts, said that the company was happy to see news of the SMCCF coming to life.

In the first quarter, rating agencies downgraded $336 million in investment-grade securities to high-yield, or “junk bond,” status, Zabel said.

That led to a $14 million increase in required capital, Zabel said.

In April, he said, rating agencies turned another $119 million of the company’s investment-grade securities into high-yield securities.

“It appears that the Fed’s Secondary Market Corporate Credit Facility program is benefiting the credit markets, producing a tightening in spreads in many of these crossover securities,” Zabel said. “This program is providing needed liquidity as a high-yield market and open the market for refinancing opportunities for many of these companies in the upper tier of the market. Overall, credit market conditions in April have improved from March, though a significant strain on Corporate America remains to be worked through, and conditions remain difficult.”

The New York Fed said Monday that the SMCCF would begin making actual investments — not simply comforting bond issuers and investors by existing — today. The SMCCF is supposed to start by investing in bond ETFs.

Here are five questions life insurers might have about their new, bond-buying buddy.

1. Does it matter that the SMCCF is starting by buying the bonds and ETFs only from “primary dealers”?

The New York Fed is trying to speed up the process of stabilizing the secondary corporate bond market by having BlackRock work with the primary dealer gorilllas. The current list of primary dealers consists entirely of investment banks, such as BofA Securities Inc., Goldman Sachs & Co. LLC, and Wells Fargo Securities LLC. The New York Fed says it may eventually buy bonds from other types of sellers, too.

2. What will the SMCCF reports actually look like?

The New York Fed says in a list of answers to frequently asked questions that it “will publicly disclose information regarding the CCFs during the operation of the facilities, including information regarding participants, transaction amounts, costs, revenues and other fees.”

The New York Fed will publish balance sheet items related to the SMCCF weekly, on an aggregated basis, on the Federal Reserve System H.4.1 statistical release titled “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks,” the New York Fed says.

3. Will the SMCCF end up cramping the life insurers’ style?

Life insurers and other investors might want to put off closing on dealers because they’d like the seller to agree to better terms. One question might be whether the SMCCF could act too quickly, and reducing the regular market players’ ability to bargain.

4. Will the SMCCF cut what life insurers make on their portfolios?

Life insurers want the bond markets to function well enough to stay in business, but they’d also like to earn more by investing in somewhat riskier BBB bonds than in U.S. Treasuries, which are seen as being risk-free. Will the SMCCF somehow hurt life insurers, by narrowing the difference between what life insurers earn on pretty safe bonds than on risk-free bonds?

5. Will the SMCCF somehow hurt near-investment grade customers?

Life insurers might want to sell products, ranging from dental insurance to large group annuities, to companies with below-investment-grade credit ratings, and to employees of those companies. One risk is that SMCCF efforts to stabilize the market for investment-grade bonds could increase turmoil in the credit market for below-investment-grade borrowers, and that this turmoil could hurt demand for insurance.

 

— Read How Fed Intervention Has Saved, but Distorted, the Bond Marketon ThinkAdvisor.

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