Background and Purpose – Commencement
As a result of tax and other revenue deferrals and other Coronavirus-related stressors affecting state and local governments, the Board of Governors of the Federal Reserve System (the “Federal Reserve”) announced on April 9, 2020, the establishment of the Municipal Liquidity Facility, to be funded with appropriations under the CARES Act. The facility is intended to support the flow of credit and liquidity to state and local governments by providing bridge, short-term financing to certain governmental issuers. Certain features of the facility have been described in a revised term sheet released by the Federal Reserve on April 27, 2020, which expanded the scope of the facility in several respects. The revised term sheet is supplemented by FAQs published by the Federal Reserve Bank of New York (“FRBNY”) on the same day. The revised term sheet and FAQs are summarized below. The terms and conditions of the facility continue to be subject to change, and further details will be announced on the Federal Reserve’s website or the FRBNY’s website.
The FRBNY will commit to lend up to $500 billion to a special purpose vehicle (or “SPV”), created for the purpose of the facility. The SPV will then use the proceeds of the loans to purchase short term notes (described in further detail below) issued by U.S. states (or entities created by multi-state compacts), the District of Columbia, and qualifying cities and counties.
The FRBNY has yet to announce the commencement date for the purchase of notes.
In addition to states and the District of Columbia, eligible issuers include U.S. counties with a population of at least 500,000 residents, and U.S. cities with a population of at least 250,000 residents. (The FRBNY has published a list of eligible counties and cities). These population requirements are substantial reductions from the requirements announced on April 9, 2020. The Federal Reserve may also approve the purchase of notes from an instrumentality that issues debt on behalf of a state or a qualifying city or county; however, there can be only one eligible issuer per state, city, or county. The FAQs published by the FRBNY indicated that the Federal Reserve is considering further expanding the facility to allow direct participation by a limited number of governmental entities that provide essential public services on behalf of the state, county or city.
To participate, states, counties, cities, or their respective instrumentalities must have long-term debt ratings from two of S&P Global Ratings, Moody’s Investors Service an Fitch Ratings, of at least BBB-/Baa3 as of April 8, 2020 and at least BB-/Ba3 at the time of purchase, and they may not be insolvent.
Tax anticipation notes (“TANs”), tax and revenue anticipation notes (“TRANs”), bond anticipation notes (“BANs”), and other similar short-term notes with maturities of 36 months or less are eligible for purchase.
The initial size of the facility is $500 billion, and the initial term of the facility ends on December 31, 2020. The SPV may purchase notes issued by or on behalf of a state or an eligible city, or county in one or more issuances of up to an aggregate amount of 20% of the general revenue from own sources and utility revenue of the applicable state, city, or county government for fiscal year 2017. The FRBNY provided the maximum limit for each eligible issuer. States and eligible cities and counties may request that the SPV purchase notes in excess of that limit in order to assist their political subdivisions and instrumentalities that do not qualify to borrow directly.
Proceeds of notes purchased by the SPV may be used to help manage the cash flow impact of:
- Income tax deferrals resulting from an extension of an income tax filing deadline,
- Deferrals or reductions of tax and other revenues or increases in expenses related to or resulting from the COVID-19 pandemic, and;
- Requirements to pay principal and interest on obligations of the relevant state, city, or county.
Additionally, a state, city or county may use the proceeds of the notes purchased by the SPV to purchase similar notes issued by, or otherwise to assist, its political subdivisions and instrumentalities for the purposes enumerated in the prior sentence, as long as those political subdivisions or instrumentalities are not insolvent. Thus, most cities and counties, and all park districts, school districts and other political subdivisions or instrumentalities, will have to access the facility indirectly subject to further expansion by the Federal Reserve. Pending further guidance, it seems that eligible issuers are not limited by sector or other parameters in determining where to inject the much-needed liquidity.
Terms and Fees
The methodology for determining the interest rate on notes to be purchased under the facility has yet to be established. However, the FAQs indicate that the rates will be “penalty” rates, which it defines as a rate that is a premium to the market rate in normal circumstances, affords liquidity in unusual and exigent circumstances, and encourages repayment of the credit and discourages use of the facility as the circumstances recede and economic conditions normalize. The interest rate will be based on the issuer’s long-term rating at the time of issuance of the note and the maturity date of the notes, and will be determined by reference to a publicly available benchmark or index plus a spread. We expect that further guidance may tie the pricing to the rating of the particular note and the underlying credit. The issuer must pay an origination fee equal to 10 basis points of the principal amount of its notes purchased by the SPV. The origination fee and other costs of issuance may be paid from the proceeds of the notes.
Eligible notes issued by states, counties and cities are expected to represent general obligations, or be backed by tax or other specified governmental revenues of the issuer. If the issuer is an authority, agency, or other entity of a state, city, or county, then either the issuer must commit the credit of, or pledge revenues of, the state, city, or county, or the state, city, or county must guarantee the notes.
The notes will be repayable in whole or in part by the issuer at any time at par.
The notes will not be required to qualify for tax exemption under the Internal Revenue Code.
The term sheet states that the eligibility of the issuers and their notes will in each case be subject to review by the Federal Reserve, and that the Federal Reserve will require relevant legal opinions and disclosures.
Issuers will need to ensure that they have the necessary legal authority under state law to issue the notes sold to the SPV, which may require the passage of authorizing legislation.
Issuers and indirect borrowers should also evaluate other credit options and any applicable restrictions on incurring debt, and consider available sources of payment of the short-term notes at maturity. Issuers are required to certify prior to issuing their notes that they are unable to secure adequately priced credit accommodations (that is, funding on terms that would otherwise be available in a normal, well-functioning lending market) from other banking institutions.
Our guidance is based on our best judgment of available information in a rapidly changing and uncertain environment. We will continue to closely monitor conditions in the primary and secondary markets for municipal securities and will update this alert as needed.
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