The Federal Reserve Board's creation of the Commercial Paper Funding Facility (CPFF), announced last Tuesday, was welcomed by ABCP market participants.
According to a release from the Fed, the special purpose vehicle will purchase directly from eligible issuers three-month U.S. dollar-denominated commercial paper at a spread over the three-month overnight index swap (OIS) rate.
The Fed will also consult with market players regarding the appropriate spreads that would be consistent with the facility's role as a funding backstop under more normal market conditions.
Before the announcement was made, issuers were having difficulty funding ABCP as they were forced by negative market conditions to roll paper overnight at very high costs.
Market players are hopeful that with the creation of the CPFF, this problem will be alleviated.
"I think it should improve market conditions for everyone - both weaker or stronger players," Omar Bolli, head of asset-backed finance at Nord LB. "Big conduit sponsors like Citigroup, Bank of America and JPMorgan benefit from having their own dealerships, and the Fed's move should help level the playing field."
Bolli added that this should improve market conditions as it gives "breathing room" to issuers. When investors are only rolling paper overnight, this increases administrative costs and is cumbersome for both ABCP investors and issuers. "Having an investor in longer maturities also engenders market confidence."
The Fed will only purchase three-month ABCP and unsecured paper rated at least 'A1'/'P1'/'F1'. Unsecured commercial paper must be secured either via an upfront fee, an endorsement or guarantee or collateral arrangements that are satisfactory to the Federal Reserve.
The details regarding the additional security for unsecured paper have not been released - nor have the specific amounts for the upfront fee required by the Fed.
Bolli said that the conditions imposed by the Fed are not restrictive. "I don't see any significant constraints in terms of eligibility, although this would also depend on the fees and additional collateral that the Fed will require for unsecured paper," he said. "The Fed did this not for the purpose of market expansion, but to create a more liquid market."
He added that, "the taxpayers should gain a large amount of income if this is used extensively, as the government funds at low Treasury bill rates and earns market interest rates on the commercial paper."
Market sources said that conceptually, the Fed could buy $1.5 trillion in commercial paper under the current eligibility requirements, although it might cover some of the costs through the fees that the Fed will be charging.
"Hopefully the Fed's move will encourage private investors to step up to the plate," Bolli added.
Meanwhile, credit market investors said that offering help to the commercial paper market could be an effective move that could foster movement in the frozen market.
"You've got to start somewhere in getting the system back up and running," said Axel Merk, manager of the Merk Hard Currency Fund. He said that investors were not buying commercial paper because of concerns about its liquidity. The Fed's program would inject that liquidity into the market. "By having the Federal Reserve in there, they're trying to heal the system from bottom up."
Many companies rely on commercial paper for simple operations, and banks' inability to sell commercial paper has threatened such basic corporate functions as payrolls.
Therefore, the Fed's CPFF could have a more immediate impact on the overall economy.
"Its results are probably going to be more immediately seen [than the $700 million bailout]; it's easier to implement and cuts across a broader swath of the economy," said Mitchell Stapley, chief fixed income officer with Fifth Third Asset Management. "It will get the commercial paper market functioning again. ... It could be instrumental in helping us move forward with this."
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