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. It is not yet known when the facility will be available to purchase notes. Certain features of the facility have been described in a term sheet released by the Federal Reserve and summarized below. However, the term sheet is subject to comment until April 16th and the terms and conditions of the program may be adjusted by the Federal Reserve and the Secretary of the Treasury. Further details will be announced on the Federal Reserve’s website.

Eligibility

A Federal Reserve Bank 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 directly purchase short term notes (described in further detail below) issued by U.S. states (including the District of Columbia), U.S. counties with a population of at least two million residents¹, and U.S. cities with a population of at least one million residents². Eligible issuers may also include an instrumentality that issues debt on behalf of a state or such a city or county; however, there can be only one eligible issuer per state, city, or county. 

The initial size of the facility is $500 billion, and the initial term of the facility ends on September 30, 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. Additional guidance on what would be considered “general revenue” and “utility revenue” for purposes of the facility is expected.   States may request that the SPV purchase notes in excess of that limit in order to assist political subdivisions and instrumentalities that do not qualify to borrow directly.

Tax anticipation notes (“TANs”), tax and revenue anticipation notes (“TRANs”), bond anticipation notes (“BANs”), and other similar short-term notes with maturities of two years or less are eligible for purchase. It is unclear if Revenue Anticipation Notes (“RANs”), anticipating other sources of revenue such as federal or state aid (without the tax component), will qualify. At this point, it is unclear what security, if any, the SPV may require in connection with the purchase of the notes.

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, offset potential reductions of tax and other revenues or increases in expenses related to or resulting from the COVID-19 pandemic, and 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. Thus, most cities and counties, and all park districts, school districts and other political subdivisions or instrumentalities, will have to access the facility indirectly.  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

Pricing will be based on the issuer’s rating at the time of issuance; details will be provided later. 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 the its notes purchased by the SPV. The origination fee may be paid from the proceeds of the notes. 

The notes are callable by the issuer at any time at par.

Approval Process

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. 

Practical Considerations

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 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.

As noted above, comments on the term sheet may be made until April 16th. They may be sent to the Federal Reserve using this feedback form. 

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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