Washington Insider-- Friday

Much of Economy Shut Out of Borrowing Boom

Here's a quick monitor of Washington farm and trade policy issues from DTN's well-placed observer.

EPA's Wheeler Raises Questions On Gap-Year Refinery Exemption Requests

So-called “gap year” petitions for small refinery exemptions (SREs) for previous compliance years are still being reviewed by EPA, and agency Administrator Andrew Wheeler said in Wisconsin he has questions about some of those petitions.

“One question that I personally have is how can you prove an economic harm in 2012 if you're still in existence today?” Wheeler said during a Wisconsin farm tour. The Department of Energy recently sent its recommendations to EPA. As for the 2021 biofuel and 2022 biodiesel recommendations and the renewable volume obligations, Wheeler said the process of determining those levels remains uncertain.

“People are still not driving as much as previous years, we take that into account when we set the RVO,” said Wheeler. “We're still going through all the data to try to figure out what the impact COVID is going to have on the RVO... Then we also have to look at what the remedy is because the appropriate remedy would not be to give people current year RINS for something from 2012 or 2013.”

He noted EPA did send a package to the Office of Management and Budget for review in May but now said that the entire landscape has changed since then. Wheeler said EPA has been proud to be able to meet the deadline for the RVO proposal the previous three years of the administration but “it does not look like we're going to be on time this year.”

It is not clear why the agency sent the plan to OMB given the uncertainty that Wheeler said exists with COVID-19.

China Official Calls On US To Stop Taking 'Restrictive' Actions

Saying the COVID-19 situation has clearly impacted China's purchases of U.S. goods and services under the Phase One agreement, Assistant Ministry of Commerce Ren Hongbin called on the U.S. to stop taking “restrictive” actions and create a more-positive atmosphere for implementing the Phase One agreement between the two sides.

"Under the current situation, it is required that the both sides need to work together and step up cooperation to overcome the difficult times," Ren stated. “We hope U.S. would stop taking any restrictions and discriminatory action against Chinese companies and create conditions for the implementation of the Phase 1 trade agreement."

U.S. Trade Representative Robert Lighthizer, Treasury Secretary Steve Mnuchin and Chinese Vice Premier Liu He are to take part in a video conference August 15 to assess the Phase One agreement status.


Washington Insider: Much of Economy Shut Out of Borrowing Boom

Bloomberg is reporting this week that the massive government stimulus now allows more companies to borrow at lower rates than ever before but, “smaller firms that power America's economic engine are often being shut out, hamstringing the recovery just as it begins.”

The Federal Reserve's pledge to use its near limitless balance sheet to buy corporate bonds has aided stricken airlines, oil drillers and hotels. It's also helped companies from Alphabet Inc. and Amazon.com Inc. to Visa Inc. and Chevron Corp. to access some of the cheapest financing ever seen.

All told, firms have sold about $1.9 trillion of investment-grade debt, junk bonds and leveraged loans this year, Bloomberg says.

Still, for companies not large enough to tap fixed-income markets, banks are tightening conditions on loans to smaller firms at a pace not seen since the financial crisis – while many direct lenders that have traditionally focused on the middle market are pulling back or turning to bigger deals.

What's more, the Fed's emergency lending programs for mid-sized businesses and municipalities have been criticized as slow, complex, and largely inaccessible, Bloomberg says.

A lack of credit for small and medium-sized firms could tip many into bankruptcy, adding to the thousands of local businesses that have already quietly disappeared. Given the sector employs roughly 68 million Americans, Fed Chair Jerome Powell calls it America's “jobs machine” and sees it as critical to regional economies across the U.S.

“The Fed actions have moved issuers that are big enough in front of the velvet rope – while those that aren't stay outside,” said Peter Atwater, an adjunct lecturer of economics at William & Mary. “Capital markets access has become a determiner of life or death for business.”

And while many economists commend the Fed for its quick and decisive actions when the pandemic hit, they also note that certain parts of the economy are clearly benefiting more than others – the big and powerful over the small and financially vulnerable, a disparity that to some degree mirrors the broader inequality problems that have been exposed by the pandemic.

The Fed announced its corporate bond-buying plan in March, opening the issuance floodgates after the coronavirus outbreak brought the market to a virtual standstill. Investment-grade firms have borrowed more than $1.3 trillion in 2020, a record pace, Bloomberg said.

Alphabet's $10 billion bond sale earlier this month saw record-low yields on the seven-year portion, besting levels set by Amazon in June. On the high-yield side, aluminum-packaging company Ball Corp. sold $1.3 billion of 10-year notes at 2.875% on Monday, the lowest ever for a U.S. speculative-grade offering with a maturity of five year or longer.

“It's a battle between the Fed's $750 billion special purpose vehicle to buy corporate investment-grade and high-yield bonds and those who don't have access to this free money,” said Stephen Blumenthal, chief executive officer at money manager CMG Capital Management Group Inc. And, it's a battle that smaller companies are decidedly losing, Bloomberg thinks.

Some 70% of bank senior loan officers surveyed by the Fed said they have tightened lending standards on loans for small commercial and industrial firms in the third quarter. The trend also extends to mid-size and larger firms, though the latter enjoy unprecedented access to capital markets.

About 54% said they increased premiums for small borrowers, the most in over a decade. Everyone is willing to lend to the biggest firms,” said Olivier Darmouni, a professor of finance at Columbia Business School. “But since the pandemic has not been tamed, creditors are now asking if the businesses will actually survive and they'll get their money back. For smaller firms, there's a lot more uncertainty of that.”

In a bid to encourage banks to extend credit to mid-size firms, the Fed introduced its $600 billion Main Street Lending Program in April—but despite efforts to broaden the program, it's issued just $253 million in loans as of Aug. 10. Critics say the program only works for a narrow set of companies, is too complex and doesn't provide enough incentive to risk-averse lenders.

Making matters worse, direct lenders, which often provide financing to small and mid-size firms, have been retrenching for months as they tend to their own portfolios, while those sitting atop the most capital are increasingly targeting bigger deals.

Of course, the tale of diverging 'haves' and 'have nots' is hardly new in credit, manifesting when economic turbulence prompts lenders to retrench and investors to seek the relative safety of stable, blue-chip firms. But the magnitude of the disparity this time around is more alarming when combined with expectations for record corporate defaults this year, Bloomberg says.

A growing chorus is also warning on inflation, which can hit smaller firms particularly hard. One of those is Larry McDonald, founder of The Bear Traps Report investment newsletter. “It's an inequality explosion in terms of financial sustainability,” said McDonald, who also authored the book 'A Colossal Failure of Common Sense' about the demise of Lehman Brothers Holdings Inc. “You have financial conditions tightening in some spots, and then wide open for the big guys – it's crazy.”

So, we will see. The Fed's credit programs are increasingly essential now, and should be watched closely as they become increasingly important to the economy across the board, Washington Insider believes.

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