Primary Dealer Credit Facility

What Was The Primary Dealer Credit Facility (History)?

The PDCF was established by the federal reserve in 2008 to try to alleviate the pressures on primary dealers that were materialising from the emerging global credit crisis. Its function was to have the authority to bail out primary dealers at very short notice, keeping them liquid and trying to stabilise the faltering economy.

Primary dealers belong to a specified list of financial corporations that are integral to the U.S. economy, for example Goldman Sachs. The PDCF was considered to be employing a high-risk strategy and was often labelled as biased in favour of various unregulated financial institutions. However, supposedly every $ of every loan under the scheme has been repaid.

PDCF Authority

The PDCF was set up specifically in light of Section 13(3) of the Federal Reserve Act, which allows the board to authorise essentially reserve loans to anyone they please when circumstances are ‘unusual and exigent’ such as during a financial crisis.

This also explains why the PDCF was disbanded again when the global economy was deemed to be recovering in 2010, although many discussions took place in a bid to make it permanent. Their power to determine the eligibility of collateral and to lend money to investment banks was of particular concern.

Loan Conditions

The loans approved by the PDCF would become high priority, senior debt and were always secured loans. The interest rate of the loans was variable to track the bank’s primary credit rate. The security of the loans came from the sale of securities in exchange for funds from the Federal Reserve.

This sale on a repurchase agreement formed the collateral of the loan (always outweighing the loan in value) and enabled the reserve to lend the money at the aforementioned rate. As these loans matured in 24 hours and because primary dealers would be allowed to reapply for them on a daily basis, fees were introduced to penalise institutions who borrowed for more than 45 consecutive days.

Risks

The authority bestowed on the PDCF was not without risk. By expanding what was deemed eligible collateral, the Federal Reserve directly weakened its own financial position to keep liquidity in the market, simultaneously taking on higher risk and mortgage backed securities, essentially lower quality debt.

The PDCF also came under fire for lending to non-bank financial institutions that were not as tightly regulated as banks and was pressurised to bring in similar regulation for those institutions. This never happened; in fact the PDCF gradually took more steps to increase eligible collateral and therefore potential liquidity for the rest of its lifetime.

The fear factor came from investment banks potentially being able to take on excessive risk with minimum penalties, backed up by the PDCF and its Federal Reserve loans. The fact that the regulation that was specifically put in place for banks to avoid moral financial hazard for the country could now be sidestepped by deregulated institutions that could mitigate their risk by borrowing from the reserve was of great concern to many economists.

https://www.newyorkfed.org/markets/primary-dealer-credit-facility/primary-dealer-credit-facility-faq

https://www.federalreserve.gov/regreform/reform-pdcf.htm

What Is A Credit Facility?

Credit facilities refer to loans made to companies or generally within corporate finance, usually from a bank. Often taken on to secure liquidity, for example after a round of financing, there are several subcategories of credit facility but the term is a broad one encompassing the different types of open/ongoing loan agreement available to businesses. Usually credit facilities consist of large loan pools that are not drawn down all at once.

Functionality

In many ways, a credit facility offers a sort of financial insurance to a company. The conditions of the loan are usually highly flexible and don’t force the company to borrow predetermined amounts. For example, a company might take out a credit facility whilst negotiating a particularly poignant deal as a revenue back up if there are delays or problems.

Advantages

The key difference between a credit facility and a regular business loan is that renegotiation is not required every time the company wishes to draw on more of the loan.

Whats more, after the initial terms of the credit facility are agreed, the company usually has a great deal of flexibility in terms of which areas of the business it may draw more of the loan to support. This can be of great benefit to the company when unexpected setbacks occur or if they need to adapt quickly to the changing financial climate affecting their specific sector.

Conditions

The terms and conditions of credit facilities vary enormously and depend on a large number of market factors including but not limited to; the company’s relationship with the financial institution; the company’s revenue; the company’s existing debt; the nature (risk assessment) of the business.

Needless to say, high performing, well established businesses enjoy more flexibility and trust than a high risk start up with mounting debt when it comes to the terms of their credit facility. Furthermore, companies who are seen to be abusing their line of credit will find it harder to secure credit facilities in future, much like a personal loan.

Case Study

In early 2009, a company with approximately $30m in revenues was severely damaged by the global recession, cutting those revenues by 30%. In response to the sharp decline in revenues and likely heeding the impact of the global credit crisis, the company’s existing credit facility was effectively frozen.

In turmoil, the company negotiated a new credit facility with 4 new lenders to supplement its existing, now frozen, facility. As their performance yoyoed over the following months, they were able to draw from (and repay to) the new credit facility until the market began to recover in mid 2011 when they were able to drop the new facility altogether and repair their relationship with the previous lender.

Revenues had in fact increased to $35m. This study shows the power of a credit facility, as in its absence, a successful company would have otherwise folded.

https://www.investopedia.com/terms/c/creditfacility.asp

https://www.wsj.com/