The Federal Reserve Board’s New Municipal Liquidity Facility
On April 9, 2020, the Federal Reserve Board announced a new Municipal Liquidity Facility loan program (the Facility) authorized under Section 13(3) of the Federal Reserve Act to provide lending support to states, the District of Columbia, the ten largest cities in the United States (those with populations in excess of 1,000,000), and the 14 largest counties in the United States (those with populations in excess of two million), each, an “Eligible Issuer”.
What is the new Facility?
The Facility is a loan program, not a grant program, as the Federal Reserve lacks authority to make grants. The Federal Reserve will create a special purpose vehicle entity (SPV), and one or more of the 12 Federal Reserve Banks will lend funds to the SPV on a recourse basis, secured by all SPV assets. The U.S. Department of the Treasury will contribute $35 billion from funds appropriated to the Exchange Stabilization Fund under the Coronavirus Aid, Relief and Economic Security Act as an initial equity investment in the SPV, but the SPV will be authorized to purchase up to $500 billion in tax, revenue, and/or bond anticipation notes and other short-term notes (Eligible Notes) issued by Eligible Issuers.
For what purpose may an Eligible Issuer use the Loan Proceeds?
The Facility is intended to address anticipated severe state and local government cash flow disruptions resulting from the COVID-19 pandemic and associated nationwide economic contraction. An Eligible Issuer may use the proceeds to manage cash flow impacts resulting from (i) income tax deferrals due to filing extensions, (ii) potential reductions of tax and other revenues or increases in expenses relating to or resulting from the COVID-19 pandemic, and (iii) debt service obligations on existing indebtedness.
The SPV will cease purchasing Eligible Notes on September 30, 2020, unless the Federal Reserve and Treasury Department extend the Facility. The Federal Reserve Banks will, however, continue to fund the SPV after such termination date until the maturity or sale of the Eligible Loans by the SPV.
What are the terms of Eligible Notes?
The aggregate principal amount of all Eligible Notes issued by any Eligible Issuer is capped at 20 percent of its general revenue from its own sources and utility revenue for fiscal year 2017. Eligible Notes will have a maximum maturity of 24 months; however, this multi-year term may require amendments to certain state law limitations on the maximum maturity of tax and revenue anticipation notes. The SPV will purchase each Eligible Note at a price based upon the Eligible Issuer’s credit rating at the time of purchase, although the standards for the pricing determinations have yet to be announced. Eligible Issuers have the option to redeem their Eligible Notes at par at any time.
Each Eligible Issuer that participates in the Facility must pay an origination fee equal to 10 basis points of the principal amount of the Eligible Note issued.
Eligible Notes will be subject to (i) eligibility review by the Federal Reserve, (ii) the delivery of legal opinions and disclosures required by the Federal Reserve prior to purchase, and (iii) applicable state law limitations on the incurrence of indebtedness by state and local governments.
What about smaller local governments?
An Eligible Issuer will be permitted to use the proceeds of its Eligible Notes purchased by the SPV to either (i) purchase similar notes issued by its political subdivisions and instrumentalities of the Eligible Issuer or (ii) otherwise make such funds available for assistance (presumably as grants). Thus, any state could choose to support the same pressing cash flow needs of its local political subdivisions with loans or grants of the proceeds of its Eligible Loans, but each state will need to determine how much of its proceeds will be shared with local governments—and establish priorities, procedures, and credit standards for local governments to apply for such available funds on an equitable basis.
Given the breadth and depth of the impacts of COVID-19, especially for states and local governments that depend heavily on volatile sales, wage, and income taxes, we expect that every state, the District of Columbia, and every qualifying city and county will want to review the terms of this Facility to ascertain whether they can take advantage of the generous terms. Given the stated termination of the Facility on September 30, 2020, the elected officials of the Eligible Issuers will need to act quickly to take advantage of this Facility and decide if and how they want to share the benefits with smaller local governments.
