The Board of Governors of the Federal Reserve System (the “Federal Reserve”), through the Federal Reserve Bank of New York (the “Reserve Bank”), is in the process of launching a new CARES Act lending program, known as the Municipal Liquidity Facility (the “MLF”), for state and local governments affected by COVID-19 pandemic.  We discuss the MLF and earlier guidance from the Federal Reserve in detail in our earlier blogs entitled “CARES Act Support for State and Local Governments – Municipal Liquidity Facility” (“MLF Blog 1”) and “Federal Releases Updated Guidance on Municipal Liquidity Facility” (“MLF Blog 2”), which can be found at: https://www.apslaw.com/its-your-business/.  On May 11, 2020, the Federal Reserve released an updated term sheet (the “Updated Term Sheet”) and frequently asked questions (the “Updated FAQs” and collectively with the Updated Term Sheet, the “Updated Guidance”) for the MLF, which are summarized below.  Readers should review the following summary in conjunction with MLF Blog 1 and MLF Blog 2.[1]

Application Process for the MLF

Eligible Issuers[2] must complete a Notice of Interest (“NOI”) package for each requested issuance of Eligible Notes.[3]  Once the Federal Reserve approves the NOI package, the Eligible Issuer may begin to document the transaction; however, before the Eligible Issuer can mail a preliminary official statement in a competitive sale transaction, and in any event prior to the pricing of any transaction, the Eligible Issuer must submit an application to the Federal Reserve. Upon approval of the application, the special purpose vehicle (“SPV”) created by the Federal Reserve to facilitate the MLF will commit to purchase the Eligible Notes. The NOI and application forms will be posted on the MLF website when available, but the Updated Guidance does not offer any additional details about the content of the forms.  Nevertheless, the pre- and post-closing disclosure requirements for the MLF, discussed in detail below, offer some insight into the level of scrutiny that Eligible Issuers may undergo during the application process.

Closing Documents and Other Requirements

The Federal Reserve expects Eligible Issuers to: (i) adapt the document forms they typically use when selling other securities to the sale of Eligible Notes; (ii) obtain CUSIP numbers for the Eligible Notes; and (iii) close the transactions through the Depository Trust Company.  Following approval of the application, the Federal Reserve will provide a purchase commitment memorializing the terms of the transaction and the conditions to funding; however, the SPV and the Federal Reserve will not execute closing or other certificates relating to the transaction.  Depending on the ultimate form of the purchase commitment, Eligible Issuers will need to confirm that the sale of the Eligible Notes to the SPV is sufficiently documented within the confines of these restrictions for state law and tax law (in the case of tax-exempt Eligible Notes) purposes.

In addition, Eligible Issuers must enter into a continuing disclosure undertaking at closing consistent with Rule 15c2-12 of the Securities Exchange Act of 1934 (“Rule 15c2-12”), even if the sale of the Eligible Notes would not otherwise be subject to Rule 15c2-12.[4]  Additional disclosure requirements are described under the heading “Disclosure Obligations” below.

Manner of Sale for Eligible Notes

The SPV will purchase Eligible Notes either directly from Eligible Issuers or indirectly as the lender of last resort in a competitive sale process.[5]  Under the latter scenario, the SPV would agree to purchase the Eligible Notes that are not otherwise awarded to other bidders.[6]

Clarification of Ratings Requirement for Eligible Issuers and Eligible Notes

Ratings Requirement for Eligible Issuers with Only One Credit Rating

An Eligible Issuer that was rated by only one major nationally-recognized statistical rating organization (“NRSRO”) as of April 8, 2020 may still qualify for the MLF if: (i) such rating was at least BBB-/Baa3 (for states, cities and counties) or A-/A3 (for a Multi-State Entity); (ii) the Eligible Issuer is rated by at least two major NRSROs as of the purchase date of the Eligible Notes; and (iii) such ratings are at least BB-/Ba3 (for states, cities and counties) or BBB-/Baa3 (for a Multi-State Entity).

Confirmation of Existing Long-Term Ratings

In pricing the Eligible Notes, the Federal Reserve will consider all of the Eligible Issuer’s long-term ratings from major NRSROs for the specific credit of the Eligible Notes.  In furtherance of this requirement, Eligible Issuers will be required to provide confirmation of such ratings as of the pricing date.  The methodology for pricing the Eligible Notes based on such ratings is further described under the heading “Pricing for Eligible Notes” below.

Ratings for Eligible Notes

Consistent with existing municipal market practices, Eligible Issuers will be required to obtain ratings for Eligible Notes offered through a competitive sale process.  In contrast, the Federal Reserve will not require ratings for Eligible Notes that are sold directly to the SPV outside of a competitive sale process.

Rating Agencies

The Updated FAQs add Kroll Bond Rating Agency, Inc. to the list of major NRSROs (S&P Global Ratings, Moody’s Investor Service, Inc. and Fitch Ratings, Inc.).

Pricing for Eligible Notes

The MLF is not intended to function as a competitor to the normal municipal securities market.  Rather, it is designed to operate as a liquidity backstop and lender of last resort for Eligible Issuers that are unable to obtain adequate credit under current market conditions.  Thus, to address the current circumstances where the market is not functioning normally, the MLF will provide funding to Eligible Issuers, but at a “penalty rate,” i.e., a premium to the market rate that otherwise would be available to Eligible Issuers in normal circumstances.[7]

Eligible Notes will bear interest at a fixed rate based on a comparable maturity overnight indexed swap (“OIS”) rate plus a spread, without regard to the method of sale (i.e., competitive sale process versus direct sale to the SPV).  The spread corresponds to the long-term ratings on the applicable credit to be used for the Eligible Notes as of the pricing date.[8]  The spread ranges from 150 basis points for AAA/Aaa-rated issuers to 590 basis points for below-investment-grade-rated issuers.  The pricing methodology is described in a pricing appendix attached to the Updated Term Sheet and included as Appendix B to the Updated FAQs (the “Pricing Appendix”).  The Pricing Appendix can be found at: https://www.newyorkfed.org/medialibrary/media/markets/municipal-liquidity-facility-pricing, but remains subject to revision depending on market conditions.  As noted in the Pricing Appendix, the interest rate is subject to 65 basis point adjustment for a taxable issuance of Eligible Notes.

In the case of a split rating (i.e., where a particular credit has received different ratings from the major NRSROs), an average rating will be determined by: (i) assigning a numerical value to each outstanding rating and (ii) rounding the average of such numerical values to the nearest numerical value that corresponds to a rating.[9] To facilitate this determination, the Updated FAQs set forth the numerical values that will be assigned to the ratings and provide a hypothetical for demonstration purposes.  In cases where a particular credit has received only two ratings and one such rating is two or more gradations higher than the other, the Eligible Issuer may either: (i) obtain a third rating and price the Eligible Notes based on the average of the three ratings or (ii) price the Eligible Notes based on the lower of the two existing ratings.

Disclosure Obligations

In order to access the MLF, Eligible Issuers will be required to provide the following pre- and post-closing disclosures to the Federal Reserve.

Pre-closing Disclosures

For Eligible Notes offered through a competitive sale process, the Eligible Issuer should expect to provide the same level of disclosure normally prepared for a public offering of notes (i.e., a preliminary official statement or other disclosure document).  In connection with a direct sale to the SPV, the Eligible Issuer must provide its financial information and operating data, as posted on the Municipal Securities Rulemaking Board’s Electronic Municipal Market Access system (EMMA) and on the Eligible Issuer’s website.[10]

Specifically, for Eligible Notes issued as TRANs, TANs, or other similar notes to be repaid from revenues, the Eligible Issuer must provide: (i) cash-flow statements (prior year actuals and 12-month projections) and either: (ii)(1) an explanation of any statutorily-required or policy-determined set asides for the repayment of the Eligible Notes or (2) a repayment plan for the Eligible Notes if set-asides are not required.  In contrast, for Eligible Notes issued as BANs, the Eligible Issuer must provide: (i) the authorization to issue the bonds to repay the BANs and (ii) an explanation of the Eligible Issuer’s plan to issue such bonds on or prior to the maturity date of the BANs.

In addition, the Eligible Issuer must provide copies of any financial information and operating data provided to the NRSROs.  The Federal Reserve may also require the Eligible Issuer to provide certain other additional information that is otherwise available to the public.

Post-closing Disclosures

The Eligible Issuer must provide on its website: (i) quarterly reports of cash flows, which show actual and projected results; (ii) access to quarterly financial reports and/or information in a format regularly provided to any governing body or the public; and (iii) from time to time (the Updated Guidance does not provide a timeframe), a report on the funding of planned set-asides, with an explanation of any negative variances.  Also, Eligible Issuers must file the following reports directly with the Federal Reserve: (i) on the dates that are six months and three months prior to maturity date of the Eligible Notes, a written report explaining the Eligible Issuer’s plan for repaying the Eligible Notes including, with respect to BANs, any material credit or other matters relating to the issuance of the bonds that will repay the BANs; and (ii) at the Federal Reserve’s request, other information relating to the Eligible Issuer’s ability to repay the Eligible Notes.

The Updated Guidance and other information can be found on the MLF website: https://www.newyorkfed.org/markets/municipal-liquidity-facility.  We will continue to provide updates regarding the MLF upon the release of further guidance from the Federal Reserve.  In the interim, if you have any questions regarding the MLF, please contact Neal Pandozzi at npandozzi@apslaw.com or Jonathan Cabot at jcabot@apslaw.com.

[1] Capitalized terms not otherwise defined in this blog have the meanings set forth in MLF Blog 1 or MLF Blog 2.

[2] An “Eligible Issuer” is a state, city or county (or, subject to Federal Reserve approval, an entity that issues securities on behalf of such state, city or county), or a multi-state entity created by a Congressionally-approved compact (a “Multi-State Entity”); provided that cities and counties meet a pre-determined population threshold.

[3] “Eligible Notes” consist of newly-issued tax anticipation notes (“TANs”), tax and revenue anticipation notes (“TRANs”), bond anticipation notes (“BANs”), and other short-term notes.  Although an Eligible Issuer may sell Eligible Notes in one or more issuances, the Federal Reserve discourages using the MLF as a line of credit through frequent, small issuances. To that end, the Federal Reserve reserves the right to establish a maximum number of issuances per Eligible Issuer or a minimum par amount per issuance.

[4] For a description of the continuing disclosure obligations under Rule 15c2-12, see our blog entitled “Disclosure Awareness in the Age of COVID-19,” which can be found at: https://www.apslaw.com/its-your-business/.

[5] The Federal Reserve has reserved the right to indicate a preference or require one type of sale at a future date.  Eligible Issuers may structure competitive sales as either a traditional “all or none” process, where one bidder is awarded the entire amount of the Eligible Notes, or a “modified Dutch auction,” where multiple bidders bid for and are awarded portions of the total par amount of the Eligible Notes.

[6] The SPV will submit a bid in a competitive sale process only in cases where the Eligible Issuer: (i) is required by law to sell the Eligible Notes competitively and (ii) does not have the authority to sell them directly to the SPV, even following a competitive sale process.

[7] As noted in the Updated FAQs, the penalty rate is required by law.  See Section 13(3) of the Federal Reserve Act and the Federal Reserve’s Regulation A.

[8] The OIS is an interest rate derivative contract whereby parties will exchange a payment priced at a fixed rate against a payment priced at an average overnight published reference rate, e.g., the effective federal funds rate.  According to the Updated FAQs, in pricing Eligible Notes, the MLF will use the fixed OIS rate based on the effective federal funds rate for the maturity that corresponds to the maturity date of the Eligible Notes.  If the Eligible Issuer selects a maturity (up to 36 months) for which no direct OIS quote is available, the OIS rate will be calculated using a straight line interpolation of the direct OIS quotes for: (i) the nearest maturity that is shorter than the maturity date of the Eligible Notes and (ii) the nearest maturity that is longer than the maturity date of the Eligible Notes.

[9]  If the resulting numerical value is equidistant between the numerical value corresponding to one rating and the numerical value corresponding to the other rating, then the Eligible Issuer will be treated as having the lower of the two ratings.

[10] Eligible Issuers must provide a direct link to the financial information on their websites and EMMA.