In the face of the coronavirus (COVID-19) pandemic, the U.S. Federal Reserve Board (the Fed) and the U.S. federal banking agencies have announced several market and supervisory actions to address the sudden market stress and strain.
The Fed is the central bank of the United States and a banking regulator, and it is taking a series of actions similar to some of those taken during the 2007 – 2008 financial crisis. The Office of the Comptroller of the Currency (the OCC) and the Federal Deposit Insurance Corporation (the FDIC) are the other U.S. federal banking regulators. The actions described below are aimed to assist banks, businesses and consumers, all of whom face unique challenges because of the sudden closure of businesses and market volatility. In doing so, the Fed is drawing upon its authority under Section 13(3) of the Federal Reserve Act. As distinct from the last financial crisis, however, these actions appear to be in reaction to shut downs in the real economy and the need for credit to be extended to a range of borrowers, rather than a perceived seizing up of the liquidity and credit of the financial institutions themselves.
We will continue to monitor legislative, supervisory and market actions taken by bank regulatory agencies as events unfold. Given the market developments since the impact of the pandemic has been absorbed, we anticipate regular developments in this space, and will regularly update this note.
The U.S. federal banking regulators, as members of the Federal Financial Institutions Examination Council (FFIEC), have announced that institutions have an additional 30 days to file their first quarter (March 31) Consolidated Reports of Condition and Income (Call Reports). Call Reports must be submitted within thirty (30) days after the original filing deadline. The grace period applies to all three versions of the Call Report (FFIEC 031, FFIEC 041, and FFIEC 051). The OCC noted that Call Reports may be amended for unintentional and incidental reporting errors within 30 days of the original filing deadline without penalty. The FDIC noted that institutions should contact their FDIC regional office if they anticipate a delayed submission.
The Fed announced a similar extension to financial institutions with $5 billion or less in total assets for submitting their March 31 Consolidated Financial Statements for Bank Holding Companies (FR Y-9C) or Financial Statements of U.S. Nonbank Subsidiaries of U.S. Bank Holding Companies (FR Y-11). Such reports must also be submitted within thirty (30) days after the original filing due date.
The Fed, the Consumer Financial Protection Bureau (CFPB), the FDIC, the National Credit Union Administration (NCUA) and the OCC (the Agencies) issued a joint statement on March 26, followed by guidance by the Fed on March 30, to encourage financial institutions to make small-dollar loans to customers who experience adverse effects as a result of the COVID-19 pandemic or to otherwise work with borrowers to re-work outstanding loans. The Agencies stated that such small-dollar loans may be offered through open-end lines of credit, closed-end installment loans, or appropriately structured single payment loans. For borrowers facing difficulties repaying a loan, the Agencies further urged financial institutions to consider workout strategies that enable a borrower to repay principal without the need to re-borrow.
The Fed, FDIC and the OCC issued a notice on March 27 permitting early adoption of the standardized approach for measuring counterparty credit risk (SA-CCR) for calculating the exposure amount of derivative contracts under the agencies’ regulatory capital rule.
The SA-CCR was finalized by the federal banking regulators in November 2019, with an effective date of April 1. In the notice, the federal banking regulators announced they will permit banking organizations to adopt SA-CCR one quarter early for the reporting period ending March 31. The early adoption is allowed to be on a best efforts basis, however upon adoption, institutions must adopt the methodology for all derivative contracts; they cannot implement the methodology for a subset of contracts. The mandatory compliance date remains January 1, 2022.
In addition, the SA-CCR rule included several other amendments to the capital rule that are effective as of April 1, 2020:
The Fed, the OCC and the FDIC issued an interim final rule on March 27 allowing banking organizations to mitigate the effects of the current expected credit loss (CECL) accounting standard on regulatory capital. On the same day, the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act) was signed into law, which also provides banking organizations optional, temporary relief from complying with CECL.
The interim final rule provides banking organizations that implement CECL before the end of 2020 the option to delay for two years an estimate of CECL’s effect on regulatory capital, relative to the incurred loss methodology’s effect on regulatory capital, followed by a three-year transition period to phase out the aggregate amount of capital benefit provided during the initial two-year delay. Under the interim final rule, a banking organization may use the five-year transition if it was required to adopt CECL for purposes of U.S. GAAP (as in effect January 1, 2020) for a fiscal year that begins during the 2020 calendar year, and elects to use the transition option in a Call Report or FR Y-9C.
In addition, the CARES Act, signed into law on March 27, provides banking organizations optional temporary relief from complying with CECL (statutory relief) ending on the earlier of the termination date of the current national emergency, declared by the President on March 13, 2020 under the National Emergencies Act, or December 31, 2020 (statutory relief period). The federal banking regulators issued a joint statement on March 31 to clarify the interaction between the CECL interim final rule and these provisions of the CARES Act.
According to the federal banking regulators, banking organizations, including those that otherwise would be required to adopt CECL in 2020 under U.S. GAAP, are not required to comply with CECL during the statutory relief period under the CARES Act. Such banking organizations may delay compliance with CECL until the statutory relief period expires. Banking organizations that elect to use the statutory relief may also elect the regulatory capital relief provided under the CECL interim final rule after the statutory relief period. Regardless of whether a banking organization utilizes the statutory relief, the five-year transition period under the CECL interim final rule begins on the date the banking organization would have been required to adopt CECL under U.S. GAAP. If a banking organization utilizes the statutory relief and then chooses to use the relief provided in the CECL interim final rule, the initial two-year transition period would be reduced by the number of quarters during which the banking organization uses the statutory relief.
The Fed announced on March 24 adjustments to its supervisory approach in response to the COVID-19 pandemic by reducing its focus on examinations and inspections and placing its focus on monitoring efforts. The statement applies to state member banks, bank holding companies, Edge Act Corporations, and U.S. operations of foreign banks, among others.
Examinations and inspections. Specifically, the Fed announced that, for supervised institutions with less than $100 billion in total consolidated assets, the Fed intends to cease all regular examination activity, except where such examination is critical to safety and soundness or consumer protection, or is required to address an urgent or immediate need. For supervised institutions with assets greater than $100 billion, the Fed intends to defer a significant portion of planned examination activity based on its assessment of the burden on the institution and the importance of the exam activity to the supervisory understanding of the firm, consumer protection, or financial stability.
The Fed intends to reassess its approach to examinations in the last week of April 2020.
CCAR Submissions. The Fed stated that financial institutions should submit their capital plans for the purposes of the Comprehensive Capital Analysis and Review by April 6, 2020.
Monitoring. The Fed noted it would focus on monitoring efforts during this time. In particular, the Fed will focus on understanding the challenges, risks and potential impacts that the COVID-19 pandemic presents for customers; staff; firm operations; and financial condition. Supervisors will continue to monitor and analyze operations; liquidity; capital; asset quality; and impact on consumers. In addition, for large financial institutions, the Fed will focus on operational resiliency and potential impacts on broader financial stability.
The Federal Open Market Committee (FOMC) announced on March 23 an expansion of its program to purchase Treasury securities and agency mortgage-backed securities (MBS), stating it would continue to purchase such assets “as necessary.” The Open Market Trading Desk indicated that it plans to conduct operations totaling approximately $75 billion of Treasury securities and approximately $50 billion of agency MBS each business day during the week of March 23. The Fed had previously announced it would purchase at least $500 billion of Treasury securities and at least $200 billion of MBS. In addition, the Fed announced it would include agency commercial MBS in its agency MBS purchases.
The Open Market Desk will also conduct overnight reverse repurchase operations, along with reverse repurchase operations with maturities of more than one day when necessary to accommodate weekend, holiday or similar trading conventions, at an interest rate of 0 percent. Such reverse repurchase transaction amounts will be limited only by the value of Treasury securities held outright in the System Open Market Account that are available for such operations and by a per-counterparty limit of $30 billion per day.
In addition, the Open Market Desk will continue rolling over at auction all principal payments from the Fed's holdings of Treasury securities and to reinvest all principal payments from its holdings of agency debt and agency MBS received during each calendar month in agency MBS. Lastly, the Open Market Desk will engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the Fed’s agency MBS transactions.
The Fed announced on March 23 the establishment of three additional loan facilities: (i) the Primary Market Corporate Credit Facility (PMCCF); (ii) the Secondary Market Corporate Credit Facility (SMCCF); and (iii) the Term Asset-Backed Securities Loan Facility (TALF). The Fed subsequently published the “Terms of Assignment for BlackRock on Behalf of the Federal Reserve Bank of New York Regarding Secondary Market Corporate Credit Facility” on March 27 (the Terms of Assignment). The Terms of Assignment noted that, with respect to the PMCCF, the parties expect to agree to terms and provisions substantially similar to those set for the SMCCF.
Under each of the PMCCF, SMCCF and TALF, Treasury will make an initial $10 billion equity investment in each Facility’s SPV using the Exchange Stabilization Fund (ESF).
The Fed established the PMCCF in order to serve as a funding backstop for corporate debt issued by eligible issuers. Under the PMCCF, the Federal Reserve Bank of New York (FRBNY) will commit to lend to a special purpose vehicle (SPV) on a recourse basis. The SPV will purchase qualifying bonds directly from and provide loans to eligible issuers. The FRBNY loan will be secured by all the assets of the SPV.
Under the SMCCF, the FRBNY will lend, on a recourse basis, to an SPV that will purchase in the secondary market corporate debt issued by eligible issuers. The SPV, for its part, will purchase eligible individual corporate bonds as well as eligible corporate bond portfolios in the form of exchange-traded funds (ETFs) in the secondary market. The FRBNY loan will be secured by all the assets of the SPV.
The TALF was established to facilitate the issuance of asset-backed securities (ABS) and improve the market conditions for ABS more generally. Under the TALF, the FRBNY will lend to an SPV on a recourse basis.
A borrower under the TALF may, at its option, pre-pay its loan, in whole or in part, but the TALF does not permit substitution of collateral during the term of the loan.
Unless extended by the Fed, the TALF will not issue new credit after September 30, 2020.
The Fed announced on March 18 the establishment of a Money Market Mutual Fund Liquidity Facility (MMMLF), which was followed by publication of an interim final rule on March 19 and the expansion of the facility on March 20. On March 21, the Fed published MMMLF FAQs (the FAQs) to clarify the scope and procedures of the MMMLF.
A “U.S. issuer” is an entity organized under the laws of the United States or a political subdivision or territory thereof, or is a U.S. branch of a foreign bank.
Also, floating rate instruments are acceptable collateral under the same fixed-rate terms and purchase price as other loans. Accordingly, the interest rate risk will be borne by the borrower.
Commercial paper that has an extendable feature such that the CP maturity date can be extended under certain conditions is not eligible to be pledged to the MMMLF.
In addition, the MMMLF may accept receivables from certain repurchase agreements. However, the facility will not, at this time, accept variable rate demand notes or tender option bonds.
This facility was established by the Fed under the authority of Section 13(3) of the Federal Reserve Act, with the approval of the Treasury Secretary.
The FAQs issued, among other things, the following clarifications:
The FAQs also addressed specific instructions to follow and documentation necessary to submit when requesting a loan under the MMMLF.
The Fed has taken measured steps to help bolster global U.S. dollar funding markets. The Fed first announced on March 19 the establishment of temporary U.S. dollar liquidity arrangements (swap lines) with additional central banks. A set of FAQs was released the same day, which provides a policy explanation of this Fed action and description of how the swap lines are structured. The Fed then announced on March 31 the establishment of a temporary repurchase agreement facility for foreign and international monetary authorities (FIMA Repo Facility), along with a set of FAQs.
The additional central banks represent countries with which the Fed established lines during the last financial crisis, but which had been allowed to expire.
Under the FIMA Repo Facility, central banks and other international monetary authorities with accounts at the FRBNY (FIMA account holders) may enter into repurchase agreements with the Fed. As part of these repurchase agreements, such account holders temporarily exchange their U.S. Treasury securities held with the Fed for U.S. dollars. These U.S. dollars can then be made available to institutions in their jurisdictions.
The Fed announced on March 17 the establishment of a Commercial Paper Funding Facility (CPFF). An update to the terms of the CPFF was later announced on March 23. In the 2008 financial crisis, the seizing up of the commercial paper market was viewed as having significant knock-on effects, including on money market mutual funds. The Fed aims to encourage continued term lending in the commercial paper market by eliminating the risk that eligible issuers of commercial paper will not be able to repay investors by rolling over their maturing commercial paper obligations.
The Fed has established the CPFF under the authority of Section 13(3) of the Federal Reserve Act, with the approval of the Treasury Secretary.
In a parallel action, the Fed announced, on March 17, 2020, the establishment of a Primary Dealer Credit Facility (PDCF). In addition, the FRBNY released a set of FAQs concerning the PDCF on March 19.
Notably, the FAQs clarifies, among other things, how funding provided through the PDCF will be treated with respect to the Liquidity Coverage Ratio (LCR). According to the FRBNY, entities subject to the LCR rule are not be required to recognize an outflow for a secured funding transaction that matures more than 30 calendar days from the calculation date. Accordingly, primary dealers that are affiliates of entities subject to the LCR rule would not recognize an outflow for so long as the maturity of the loan is not within 30 calendar days of a firm’s calculation date. The FRBNY noted that as the remaining maturity of the loan declines, the primary dealer may choose to pre-pay the loan and request a new loan up to 90 days.
This facility was also established by the Fed under the authority of Section 13(3) of the Federal Reserve Act, with the approval of the Treasury Secretary. The FAQs also note that borrowing will be disclosed in accordance with Section 13(3).
The Fed announced on March 23 the issuance of an interim final rule to phase in gradually the automatic restrictions associated with a firm’s total loss absorbing capacity, or TLAC, buffer requirements. Similar to the March 17 interim final rule described below, the purpose of this interim final rule is to revise the definition of “eligible retained income” so that, if there are reductions in capital ratios, the limitations on capital distributions apply in a more gradual manner rather than in a sudden and severe manner.
The Fed, OCC and FDIC also announced on March 17 a technical change to their capital regulations to phase in gradually the restrictions on capital distributions and discretionary bonus payments that automatically apply if a bank’s capital levels decline. The change was made by the issuance of an interim final rule that will be effective upon its publication in the Federal Register (expected in a few days after the announcement).
The Fed announced on March 15 (a Sunday) that it would cut its benchmark federal funds rate by a full percentage point to zero. As of the date of this publication, the Fed Funds target rate was in a range of 0 to 0.25 percent, down from a range of 1 to 1.25 percent.
Also on March 15, the Fed, together with the European Central Bank, Bank of England, Bank of Japan and the Swiss National Bank, announced coordinated action to enhance liquidity through standing U.S. dollar liquidity swap line arrangements. The pricing on such arrangements will be the U.S. dollar overnight index swap rate plus 25 basis points, which represents a reduction in the rate by 25 basis points.