Client Alert
On April 27, 2020, the Federal Reserve announced changes to the Municipal Lending Facility described in our April 13, 2020, Client Alert, as updated on April 22, 2020, Questions and Answers about the Municipal Liquidity Facility Established by the Federal Reserve under the CARES Act.1 The press release describing the changes is attached as Attachment I. The new term sheet for the facility is attached as Attachment II.
The changes:
- expand the list of Eligible Issuers to include:
- any city with a population over 250,000 (compared to the 1 million original minimum);
- any county with a population over 500,000 (compared to the 2 million original minimum); and
- any multi-state entity established under the Compact Clause of the US Constitution.
- impose an investment grade rating requirement for Eligible Issuers (compared to an unspecified standard satisfactory to the Federal Reserve);
- extend to three years the maximum maturity of Eligible Notes (compared to 2 years originally);
- extend the availability of the facility from September 30, 2020, to December 31, 2020;
- establish an expectation that Eligible Notes purchased under the facility will be general or revenue obligations “generally consistent with the source of repayment and strongest security typically pledged to repay publicly offered obligations of the Eligible Issuer”; and
- clarify and modify other matters in the term sheet as shown on the marked version of the term sheet attached as Attachment III showing the differences between the original and new term sheets.
At the same time, the Federal Reserve Bank of New York (FRBNY), as sole Reserve Bank lender for the facility, issued a FAQs for the facility that is attached as Attachment IV. After first describing in more detail the changes to the term sheet outlined above, we update below our Questions and Answers in our earlier Client Alert based on those changes and the FRBNY FAQs.
- The expanded list of Eligible Issuers.
(a) Cities and (b) Counties: The Federal Reserve has established the eligibility of cities based on 2018, and counties based on 2019, Census Bureau data. Attachment V (which is Appendix A to the FAQs) lists every city and county that can be an Eligible Issuer based on that population data. The Federal Reserve explained that list will not change based on any population updates.
(c) Multi-State Entities: There are currently over 200 Multi‑State Entities.2 The term sheet does not limit such entities, so that any newly created Multi-State Entity should be able to become an Eligible Issuer by meeting the other requirements for an Eligible Issuer.
1. The investment grade rating requirement.
States, counties, and cities (including any entity that issues on its behalf, as explained below) must have been rated investment grade (i.e., BBB-/Baa3 or higher) by at least two nationally recognized statistical rating organizations (NRSROs) as of April 8, 2020. If such an issuer has been downgraded since April 8, 2020, it must be rated at least BB-/Ba3 at the time the facility purchases an Eligible Note from that issuer.
Multi-State Entities are subject to the higher rating requirement of A-/A3 as of April 8, 2020. If downgraded, they must still be rated at least BBB-/Baa3 at the time the facility purchases an Eligible Note from such an issuer. As with the other Eligible Issuers, a Multi-State Entity must have the required ratings from at least two NRSROs.
2. The new maturity limit for Eligible Notes.
The revised term sheet permits Eligible Notes to have a maturity of up to three years, rather than the two-year limit in the original term sheet. The Federal Reserve retains the right to review each Eligible Note and has no obligation to purchase any note. This is also, of course, true for the new rating requirements. The Federal Reserve has no obligation to purchase an Eligible Note under the facility just because it meets the minimum rating requirements.
3. The extended availability of the facility and possible further support.
In addition to extending the facility to December 31, 2020, “to provide eligible issuers more time and flexibility,” the Federal Reserve stated in its press release that it “will continue to closely monitor conditions in primary and secondary markets for municipal securities and will evaluate whether additional measures are needed to support the flow of credit and liquidity to state and local governments.”
4. General expectations regarding source of repayment and security for Eligible Notes.
While not establishing any firm requirements for Eligible Notes beyond the ratings requirements described in item 2 above, the Federal Reserve explained the notes should be “generally consistent with the source of repayment and strongest security typically pledged to repay publicly offered obligations of the Eligible Issuer,” as noted above, and that for States, counties, and cities “will generally be expected to represent general obligations of the Eligible Issuer, or be backed by tax or other specified governmental revenues of the applicable State, City, or County.” In addition, if “the Eligible Issuer is an authority, agency, or other entity of a State, City, or County, such Eligible Issuer must either commit the credit of, or pledge revenues of, the State, City, or County, or the State, City, or County must guarantee the Eligible Notes issued by such issuer.”
For Multi-State Entities, “the Eligible Notes will be expected to be parity obligations of existing debt secured by a senior lien on the Multi-State Entity’s gross or net revenues.”
5. Call rights eliminated and replaced with partial or full prepayment only if Federal Reserve approves.
The original term sheet provided an Eligible Issuer could call Eligible Notes at any time at par. The new term sheet provides Eligible Notes “may be prepaid by the Eligible Issuer at any time, in whole or in part, at par prior to maturity with the approval of the Federal Reserve.”
6. Additions, clarifications, and elaborations.
(a) Possibility of more than one issuer per Eligible Issuer. The term sheet continues to state that only “one issuer per State, City, County, or Multi-State Entity is eligible,” but adds that “the Federal Reserve may approve one or more additional issuers per State, City, or County to facilitate the provision of assistance to political subdivisions and other governmental entities of the relevant State, City, or County.”
This suggests the Federal Reserve would consider a request from a State, county, or city to permit multiple entities to issue Eligible Notes on its behalf. The FAQs provides no indication how the Federal Reserve would consider such a request.
(b) Exact dollar limits specified for each State, county, and city. The term sheet continues to specify the “SPV may purchase Eligible Notes issued by or on behalf of a State, 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 (OGSUR) of the applicable State, City, or County government for fiscal year 2017,” but Appendix A to the FAQs,3 which is Attachment V to this Client Alert, specifies both the OGSUR and the maximum aggregate Eligible Note amount for each State, county, and city eligible to become an Eligible Issuer, subject to the original term sheet’s proviso that the Federal Reserve will consider additional lending “in excess of the applicable limit in order to assist political subdivisions and other governmental entities that are not eligible for the Facility.” Also, the FAQs notes that “ The list in Appendix A may be revised if changes are made to the MLF. Please check this website for any revisions and sign up for email alerts.”
(c) Greater flexibility in use of proceeds. As shown in the Attachment III marked version of changes to the term sheet, the Use of Proceeds section now permits Eligible Issuers to use funds to cover deferrals, not only reductions, in tax receipts related to the pandemic and to pay outstanding principal and interest on obligations of not only the Eligible Issuer but also its political subdivisions or other governmental entities.
(d) “Instrumentalities” replaced with “entity” or “governmental entity.”
The new term sheet replaces references to “instrumentality” with “entity” or “government entity,” so that a State, county, or city can issue through an “entity” (that issues securities on behalf of the State, City, or County for the purpose of managing its cash flows) rather than an “instrumentality” and a State, county, or city can use the proceeds of Eligible Notes to purchase securities issued by political subdivisions and “other governmental entities” rather than “instrumentalities.”
Updated Questions and Answers Reflecting the April 27, 2020 Term Sheet
What is the purpose of the municipal liquidity facility?
The term sheet states that the facility “will support lending” to States, the District of Columbia, cities with a population over 250,000, counties with a population over 500,000, and Multi‑State Entities. The facility, however, does not “support” such lending by purchasing municipal debt in the secondary market. Instead, the facility provides for purchases of certain short-term securities directly from the State (including DC), city, county, or Multi-State Entity that issues (or on whose behalf another entity issues) the securities. The facility, therefore, provides direct funding to the borrowers.
The FAQs explains that the “immediate purpose” of the facility “is to enhance the liquidity of the primary short-term municipal securities market through the purchase” of Eligible Notes at issuance. “The Eligible Issuer’s proceeds from the sale of Eligible Notes to the SPV can in turn be used to support its political subdivisions and public authorities, among other uses. The Facility will provide a form of cash management financing to Eligible Issuers. In addressing the cash management needs of Eligible Issuers, the Facility will also help restore confidence in the municipal securities market.”
Will this be the only facility the Federal Reserve will establish to help municipal issuers?
The FAQs explains that the “Federal Reserve will continue to closely monitor conditions in the primary and secondary markets for municipal securities and will evaluate whether additional measures are needed to support the flow of credit and liquidity to state and local governments.”
How will the Federal Reserve fund States, cities, or counties under the facility?
The Federal Reserve Bank of New York (FRBNY) will make loans to a single special purpose vehicle (SPV) to finance the SPV’s purchases of “Eligible Notes” issued by “Eligible Issuers.”
As noted above, the FRBNY has issued a FAQs4 that provides details for the facility, and which is also attached as Attachment IV to this Client Alert.
How will the FRBNY administer the program?
The FAQs explains that the FRBNY has selected PFM Financial Advisors LLC (PFM) as its administrative agent” for the facility. In serving as the administrative agent, PFM will coordinate and review the applications” under the facility based on criteria established by the FRBNY.
The FAQs also explains that questions about the facility should be directed to this link5 or via email to MLF@ny.frb.org.
You can also sign up for updates about the facility at email alerts.6
What is an Eligible Issuer under the facility?
Any State, including the District of Columbia, any city with a population of more than 250,000, as identified on Attachment V, any county with a population of more than 500,000, as identified on Attachment V, any Multi-State Entity, and, subject to Federal Reserve review and approval, an entity that issues securities on behalf of the State, City, or County for the purpose of managing its cash flows.
The FAQs also explain that the “Federal Reserve is also considering expanding” the facility to allow a limited number of governmental entities that provide essential public services on behalf of a State, City, or County to participate directly in the facility as “Eligible Issuers, taking into consideration the objective of quickly and efficiently making” the facility “available to the currently defined set of Eligible Issuers.” “The inclusion of any such additional Eligible Issuers would be publicly announced at a future date. The Federal Reserve continues to encourage Eligible Issuers to make funding from the Facility available to their political subdivisions and other governmental entities that are in need of such funding.”
What is a Multi-State Entity?
The term sheet explains that a “Multi-State Entity is an entity that was created by a compact between two or more States, which compact has been approved by the United States Congress, acting pursuant to its power under the Compact Clause of the United States Constitution.
The National Center for Interstate Compacts has information on such entities.7 According to the NCIC, there are more than 200 such entities.8 The Port Authority of New York and New Jersey is an example of a Multi-State Entity.
Can an Eligible Issuer delegate its borrowing to an entity it has established to issue securities to manage its cash flows?
Yes, except for Multi-State Entities. The term sheet explicitly includes such entities as Eligible Issuers on behalf of a State, county, or city (but not a Multi-State Entity). Only one issuer per State, City, or County, or Multi-State Entity is eligible, unless the Federal Reserve approves one or more additional issuers per State, city, or county to “facilitate the provision of assistance to political subdivisions and other governmental entities” of the relevant State, city, or county.
Thus, either (a) a State or (b) an entity that issues securities on behalf of the State could issue Eligible Notes, but both could not, unless the Federal Reserve approves otherwise, as described above. The same would be true for any county or city eligible to issue Eligible Notes under this facility.
The FAQs explains that such an issuing entity must either (1) have the ability to commit the credit of, or pledge revenues of, or (2) be guaranteed by, the applicable State, city, or county.”
How many eligible issuers could there be in any single State?
There is no limit on the number of cities or counties that could be Eligible Issuers in a single State, so long as each has the required population. In addition, as noted in answer to the previous question, the Federal Reserve can approve more than one issuer for each Eligible Issuer, but the general rule is only one issuer per State, city, or county, or Multi-State Entity is eligible.
What is the rating requirement for an Eligible Issuer?
As explained above, States, counties, and cities (including any entity that issues on its behalf, as explained below) must have been rated investment grade (i.e., BBB-/Baa3 or higher) by at least two nationally recognized statistical rating organizations (NRSROs) as of April 8, 2020. If such an issuer has been downgraded since April 8, 2020, it must be rated at least BB‑/Ba3 at the time the facility purchases an Eligible Note from that issuer.
Multi-State Entities are subject to the higher rating requirement of A-/A3 as of April 8, 2020. If downgraded, they must still be rated at least BBB-/Baa3 at the time the facility purchases an Eligible Note from such an issuer. As with the other Eligible Issuers, a Multi-State Entity must have the required ratings from at least two NRSROs.
What are the available NSROs?
The FAQs explains: “Currently, the ratings criteria for the MLF refer to ratings provided by three NRSROs: S&P Global Ratings, Moody’s Investor Service, Inc., and Fitch Ratings, Inc. The Federal Reserve is considering including other NRSROs under the MLF.”
Will each Eligible Note need to be rated?
Yes, either through a ratings reaffirmation or a new rating. The FAQs states that “ at the time of sale or pricing of the Eligible Notes, the Federal Reserve will require a confirmation of any outstanding long-term ratings of the Eligible Issuer by each major NRSRO that has an outstanding rating of the Eligible Issuer relating to the same type or source of repayment and security as is offered for the Eligible Notes, along with evidence that such NRSROs have been notified of the issuance of the Eligible Notes by the Eligible Issuer. If an Eligible Issuer does not have an outstanding long-term rating, it will be required to apply for and be assigned a rating on the Eligible Notes by at least two major NRSROs prior to the sale or pricing of the Eligible Notes.”
What is an Eligible Note that the SPV could purchase under the facility?
The term sheet states: “Eligible Notes are tax anticipation notes (TANs), tax and revenue anticipation notes (TRANs), bond anticipation notes (BANs), and other similar short-term notes issued by Eligible Issuers, provided that such notes mature no later than 36 months from the date of issuance. In each case, a note’s eligibility is subject to review by the Federal Reserve.”
Obviously, the Federal Reserve will determine on a case by case basis what “notes” it will permit the SPV to purchase. It seems clear the Federal Reserve intends to fund notes that are expected to be repaid from future (1) taxes and other revenues, (2) bond issuances, or (3) other moneys that the issuer can foresee receiving.
The FAQs explains “TANs and TRANs are generally backed by and rated based on the anticipated receipt of tax and other revenues over the course of a fiscal year or longer, in amounts sufficient to pay off the notes by maturity.” On the other hand, “BANs are issued in anticipation of future bond issuance and are typically not secured by a pledged revenue stream, but are rated based on the long-term credit rating of the issuer and its assumed future market access for refinancing (either as new BANs or long-term bonds).”
Can Eligible Notes be either general or revenue obligations?
Yes. The term sheet states “The source of repayment and security for Eligible Notes will depend on the applicable constitutional and statutory provisions governing the Eligible Issuer and should be generally consistent with the source of repayment and strongest security typically pledged to repay publicly offered obligations of the Eligible Issuer. Eligible Notes issued by Eligible Issuers that are not Multi-State Entities will generally be expected to represent general obligations of the Eligible Issuer, or be backed by tax or other specified governmental revenues of the applicable State, City, or County. If the Eligible Issuer is an authority, agency, or other entity of a State, City, or County, such Eligible Issuer must either commit the credit of, or pledge revenues of, the State, City, or County, or the State, City, or County must guarantee the Eligible Notes issued by such issuer.”
What would be the security for Eligible Notes issued by Multi-State Entities?
The term sheet states that a Multi-State Entity’s Eligible Notes “will be expected to be parity obligations of existing debt secured by a senior lien on the Multi-State Entity’s gross or net revenues.”
Is three years the maximum maturity for the Eligible Notes sold to the SPV?
Yes. As quoted above, the term sheet specifies that Eligible Notes must “mature no later than 36 months from the date of issuance.”
Is there a limit on the amount of Eligible Notes an Eligible Issuer can sell to the SPV?
Yes. The term sheet states: “The SPV may purchase Eligible Notes issued by or on behalf of a State, 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.”
As explained above, Appendix A to the FAQs (Attachment V to this Client Alert) lists the maximum aggregate Eligible Note amount for each State, county, and city eligible to become an Eligible Issuer, subject to the proviso that the Federal Reserve will consider additional lending “in excess of the applicable limit in order to assist political subdivisions and other governmental entities that are not eligible for the Facility.” Also, the FAQs notes that “ The list in Appendix A may be revised if changes are made to the facility. Please check this website for any revisions and sign up for email alerts.” In establishing such amounts, the term sheet links to this U.S. Census Bureau webpage9 for those revenue amounts.
What does it mean that a State “may request that the SPV purchase Eligible Notes in excess of” this limit “to assist political subdivisions and instrumentalities that are not eligible for the Facility”?
The Federal Reserve seems to contemplate that it might approve extra Eligible Note issuances to permit a State to provide additional funding to cities and counties that do not meet the population requirements for direct issuances of Eligible Notes or for other political subdivisions and other governmental entities that are not eligible for the facility.
Is an Eligible Issuer otherwise restricted in how it can use the proceeds from the sale of Eligible Notes?
Yes. The term sheet states: “An Eligible Issuer may use the proceeds of Eligible Notes purchased by the SPV 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 for the payment of principal and interest on obligations of the Eligible Issuer or its political subdivisions or other governmental entities. An Eligible Issuer (other than a Multi-State Entity) may use the proceeds of the notes purchased by the SPV to purchase similar notes issued by, or otherwise to assist, political subdivisions and other governmental entities of the relevant State, City, or County for the purposes enumerated in the prior sentence.”
This suggests an Eligible Issuer will have fairly broad discretion in how it uses the proceeds from Eligible Note sales, including for paying principal of and interest on obligations incurred for purposes unrelated to the COVID-19 pandemic. Aside from such payments on outstanding debt, however, it seems there will need to be some connection to the pandemic.
The FAQs explains that proceeds may also be used “to fund the costs of issuing the Eligible Notes and paying the SPV issuance fee.”
What are the fees for an Eligible Issuer to sell Eligible Notes under this facility?
A 10 basis points (i.e., 1/10 of 1%) origination fee on the principal amount of the Eligible Notes sold to the SPV.
This is the only fee specified in the term sheet.
Aside from that 10 bps origination fee, what is the pricing for the Eligible Notes?
The term sheet states: “Pricing will be based on an Eligible Issuer’s rating at the time of purchase with details to be provided later.”
The FAQs states: “Under Section 13(3) of the Federal Reserve Act and the Board’s Regulation A, the interest rate on the Eligible Notes must be a penalty rate, meaning 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 unusual and exigent circumstances that motivated the program recede and economic conditions normalize.
The Federal Reserve will establish a pricing methodology that will be broadly applicable to all Eligible Issuers. The methodology will be based on the Eligible Issuer’s long-term rating at the time of purchase of the Eligible Notes and the maturity of the Eligible Notes, plus a spread over a publicly available benchmark or index.”
The “penalty rate” is required by law (Section 13(3) of the Federal Reserve Act, as noted above). This is because the Federal Reserve is supposed to be the “lender of last resort,” not a competitor to the normal municipal securities market. In the current circumstances, however, that market is not functioning well, and the facility is intended to address that situation by providing funding above “normal” interest rates.
Does this mean an Eligible Issuer is required to show it can not obtain funding through the normal municipal securities market, including through banks?
The FAQs explains that the “Federal Reserve must obtain evidence that participants” in the facility are “unable to secure adequate credit accommodations from other banking institutions. In certifying whether the issuer is unable to secure adequate credit accommodations from other banking institutions, issuers may consider economic or market conditions in the market intended to be addressed” by the facility “as compared to normal conditions, including the availability and price of credit. Lack of adequate credit does not mean that no credit is available. Lending may be available, but at prices or on conditions that are inconsistent with a normal, well-functioning market.”
Can an issuer call the Eligible Notes it has sold to the SPV?
No. The original term sheet provided for a call at any time at par, but the new term sheet states: Eligible Notes purchased by the SPV may be prepaid by the Eligible Issuer at any time, in whole or in part, at par prior to maturity with the approval of the Federal Reserve.” Thus, the Federal Reserve will need to approve any prepayment.
When can Eligible Issuers begin selling Eligible Notes to the SPV?
The FAQs states: “Federal Reserve staff is working expeditiously to operationalize the MLF. The Federal Reserve will keep market participants apprised and announce in advance when the SPV will commence operations and begin purchasing Eligible Notes.” The FAQs also states: Questions should be directed through this link10 or via email to MLF@ny.frb.org and that anyone can sign up for email alerts email alerts.11
For how long will the SPV make such purchases?
Until December 31, 2020, unless the Federal Reserve extends that date. The term sheet states: “The SPV will cease purchasing Eligible Notes on September 31, 2020, unless the Board and the Treasury Department extend the Facility. The Reserve Bank will continue to fund the SPV after such date until the SPV’s underlying assets mature or are sold.”
- insights-publications-Federal_Reserve_Municipal_Liquidity_Facility_CARES_Act.html
- https://www.csg.org/knowledgecenter/docs/ncic/FactSheet.pdf
- https://www.newyorkfed.org/medialibrary/media/markets/municipal-liquidity-facility-eligible-issuers
- https://www.newyorkfed.org/markets/municipal-liquidity-facility/municipal-liquidity-facility-faq
- http://www.federalreserve.gov/apps/contactus/feedback.aspx?refurl=/muni/
- https://public.govdelivery.com/accounts/USFRBNEWYORK/subscriber/new?topic_id=USFRBNEWYORK_486
- https://www.csg.org/NCIC/compacts.aspx
- https://www.csg.org/knowledgecenter/docs/ncic/FactSheet.pdf
- https://www.census.gov/data/datasets/2017/econ/local/public-use-datasets.html
- http://www.federalreserve.gov/apps/contactus/feedback.aspx?refurl=/muni/
- https://public.govdelivery.com/accounts/USFRBNEWYORK/subscriber/new?topic_id=USFRBNEWYORK_486
