The Federal Reserve may subsidise America’s companies by purchasing their short-term debt at rates below those demanded by private investors in the $1.6 trillion commercial-paper market.
Fed officials yesterday set the yield they will pay for commercial paper at about 1.6 percentage points less than the average cost for financial companies, weekly central bank data show. Policy makers last week announced emergency plans to buy the securities after the market shrank to a three-year low.
The discount cuts the cost of cash to 2.2 per cent from 3.7 per cent for General Electric Co and from 4.7 per cent for Citigroup Inc, data compiled by Bloomberg show. One possible unintended consequence: private buyers are shut out.
“The Fed can drive everybody else out of the market” for buying commercial paper unless market yields drop, said Robert Eisenbeis, chief monetary economist at hedge fund Cumberland Advisors Inc in Vineland, New Jersey, who used to work at the Atlanta Fed. That could end up “assuring that markets won’t restart,” he said.
The subsidy underscores officials’concerns over the market, which serves as a checking account for dozens of corporations for paying wages and suppliers, and as a source of financing for consumer credit.
Officials are setting up a special fund to buy the commercial paper, and will start the program on October 27, the central bank said in a statement yesterday. Pacific Investment Management Co of Newport Beach, California, is in talks to run the plan.
Borrowing Term: Fed staff officials said last week that because the market’s disruption meant some companies could only borrow for short periods, even overnight, the Fed will purchase three-month securities.
The central bank will buy only debt with the top short-term ratings of A-1, F1 and P-1 given by Standard & Poor’s, Fitch Ratings and Moody’s Investors Service respectively.
To set up the so-called special purpose vehicle that will buy the debt, the central bank will loan to it at the 1.5 per cent benchmark federal funds rate, the target for the overnight rate between banks. The yields set by the Fed would offer the fund a return over its cost of financing.
Yesterday, the Fed said it will pay a premium of 1 percentage point over the overnight-index swap rate, which is currently 1.21 per cent. It may also charge a further fee of 1 percentage point if the issuer doesn’t get a guarantee for its debt or offer some security for it in case of default.
Below Market: The Fed facility would finance the short-term notes at 2.2 per cent yields at current rates, or 3.2 per cent with the fee.
By comparison, GE is offering 3.7 per cent to issue 90-day paper, the most all year, Bloomberg data show. Citigroup October 13 posted a rate of 4.7 per cent to sell the debt, the most since December 24. American Express Co yesterday offered 3.9 per cent to issue three-month commercial paper, about the highest since January.
GE has no current plans to tap the Fed’s program, Keith Sherin, the company’s chief financial officer, said in an October 10 conference call. It would use it if conditions became serious enough, and would be eligible to sell a total of $60 billion through its GE Capital unit and $10 billion from the parent company, Sherin said.
Danielle Romero-Apsilos, a Citigroup spokeswoman, declined to comment.
Four-Week Slide: The Fed Board invoked emergency powers to set up the so- called Commercial Paper Funding Facility on October 7.
Companies from newspaper firm Gannett Co to electricity producer Southern Co have been forced to tap credit lines or forego raising debt because of the commercial-paper market’s disruption.
For asset-backed commercial paper, the Fed will pay 3 percentage points over the OIS rate, a measure of traders’ expectations for the Fed’s benchmark rate. No fee will be charged. That would amount to a current rate of 4.22 per cent. Quoted yields on 90-day asset-backed commercial paper are 4.48 per cent.
All borrowers will be required to pay the Fed a registration fee to join the program of 10 basis point of the maximum amount of commercial paper they had outstanding in the period of January to August.
Commercial paper spreads over the three-month OIS swap rate for financial borrowers averaged 0.6 per cent in the first eight months of the year. If the market returned to those averages, the Fed facility would result in a penalty rate.
Above ‘Normal’: The Fed’s pricing plan “would be below a market rate, but it isn’t a low rate by any means relative to what was normal,” says Tony Crescenzi, chief bond market strategist at Miller Tabak & Co LLC in New York.
The average spread between financial commercial paper rates the overnight index swap rate stood at 2.62 percentage points yesterday. The collapse of Lehman Brothers Holdings Inc on Sept. 15 eroded confidence in the credit markets.
“Confidence had evaporated about the ability of companies to repay their debts,” said Crescenzi. “The uncertainties about exposures kept people from investing. The economy was also collapsing.”
