'Not a panacea': UBS explains why half of the companies the Fed is targeting with its $2 trillion loan stimulus may still go bust

• The Federal Reserve's loan support to Main Street may only help roughly half of the eligible companies, said Matthew Mish, the head of credit strategy at UBS.
• Much will depend on when the economy can reopen without triggering a new wave of coronavirus infections, Mish said.
• He explained other limitations of the Fed's stimulus, and discussed parts of the credit market that he considers relatively safer amid the coronavirus-led downturn.
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Not every company that qualifies for the Federal Reserve's loan support will survive the coronavirus-led downturn.

That's one of the takeaways from UBS credit strategists following their assessment of the additional $2.3 trillion stimulus the central bank announced last week.

The Fed made two noteworthy updates to its economic boosters. First, its so-called Secondary Market Corporate Credit Facility was expanded to include the high-yield market. The Fed had pledged to only purchase exchange-traded funds exposed to companies with quality investment-grade ratings.

The Fed's second update - and the one UBS expects to be more impactful for companies with weaker credit ratings - was the introduction of two Main Street loan facilities with up to $600 billion in purchasing power. Companies that employ up to 10,000 people or produce less than $2.5 billion in revenues are eligible, with conditions that include a commitment to retain workers.

These unprecedented injections into the economy come after loud and clear warnings about the risks to high-yield companies that are mired in debt.

Rating agencies consider these firms as more likely to default on their repayments or seek bankruptcy protection, particularly in a recession. Despite the Fed's rescue efforts, these companies may struggle to remain in business and could be downgraded deeper into junk territory by the raters.

"For now we assume direct Fed loan support helps 50% of those eligible; i.e., distressed firms become non-distressed," Matthew Mish, the head of credit strategy at UBS, said in a recent note.

He continued: "Without specific single name analysis, this estimate is effectively the coin toss because the actual figure is below 100% and above 0%. That implies half or $0.15tn of eligible issuers avoid distress with Fed loans (9% leveraged loans, 10% middle-market, 19% high-yield)."

To explain why, Mish borrowed the words of Fed Chairman Jerome Powell, who said the loans represent "lending powers, not spending powers." This means no company is receiving a handout and all are expected to repay the Fed.

In reality, not every company that qualifies on paper will be able to pull this off, Mish noted. Some may suffer from long-term effects of the pandemic such as reduced travel and office-space rentals. Others may require assistance beyond September 30, which is the current termination date of the Fed's facilities.

Mish previously named the following industries as having high exposure to the crisis: air transport, automotive, hotels/motels/inns and casinos, leisure, rail, and surface transport.

Overall, the success of the Fed's initiatives hinges on when the economy can be reopened without causing a new wave of COVID-19 infections.

"The Fed's actions are not a panacea - at least as currently advertised," Mish said. "Our consumer health gauge has deteriorated to levels on par with the great financial crisis and looks likely to worsen. Non-bank lender stress and defaults risk a prolonged credit crunch."

He added: "QE and lending programs can help support financial assets, but ultimately real assets like commodity and home prices have or will fall due to lack of demand."

There will be some beneficiaries, however. The biggest will be companies with BB and BBB ratings since the Fed's purchasing power will be concentrated here, Mish said.

"On a relative value basis, we like investment grade over high yield, high yield over leveraged loans, BBs over B/CCCs and small vs. large middle-market loans," he concluded.

Get the latest coronavirus business & economic impact analysis from Business Insider Intelligence on how COVID-19 is affecting industries.

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