The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), which was enacted into law on March 27, 2020, established an emergency lending program for state and local governments due to the COVID-19 pandemic. This lending program will be administered by the Board of Governors of the Federal Reserve System (the “Federal Reserve”) through the emergency lending provisions of Section 13(3) of the Federal Reserve Act.
To implement the lending program, on April 8, 2020, the Federal Reserve authorized the establishment and operation of a Municipal Liquidity Facility (the “MLF”). The MLF will support lending to: (1) states (including the District of Columbia); (2) cities with a population exceeding one million residents; (3) counties with a population exceeding two million residents; and (4) instrumentalities that issue on behalf of any of the foregoing entities for the purpose of managing its cash flows, in each case subject to review and approval by the Federal Reserve (collectively, the “Eligible Issuers”). Only one issuer per state, city, or county is eligible to participate in the MLF.
Under the MLF, the Federal Reserve Bank of New York (the “Reserve Bank”) will commit to lend to a special purpose vehicle (“SPV”) on a recourse basis. The Reserve Bank’s loan to the SPV will be secured by all of the assets of the SPV. Subject to an eligibility review by the Federal Reserve, the SPV will then purchase newly-issued tax anticipation notes, tax and revenue anticipation notes, bond anticipation notes, and other short-term notes directly from Eligible Issuers with maturities no later than two years from the date of issuance (collectively, the “Eligible Notes”). At the end of the two-year period, the Eligible Issuer would need to either repay the Eligible Notes with available cash or refinance the Eligible Notes with bonds or other obligations; provided, that the Eligible Issuer may call the Eligible Notes at any time at par. The SPV will cease purchasing Eligible Notes on September 30, 2020, subject to extension by the Federal Reserve and the U.S. Treasury Department.
Using funds appropriated to the Exchange Stabilization Fund under Section 4027 of the CARES Act, the United States Department of the Treasury (the “Treasury Department”) will make an initial equity investment of $35 billion in the SPV. Ultimately, the SPV will be able to purchase an aggregate amount of up to $500 billion (subject to certain deductions) of Eligible Notes. The Eligible Notes may be issued in one or more issuances, of up to an aggregate amount of 20% of the Eligible Issuer’s general revenues (income, property and sales tax revenues, for example) and utility revenues for fiscal year 2017.[1] However, to assist political subdivisions and instrumentalities that are not eligible to participate in the MLF, states may request that the SPV purchase Eligible Notes in excess of this limit.
In addition to its eligibility review, the Federal Reserve will also determine the closing conditions, including relevant legal opinions and disclosures, for the MLF. Pricing (i.e., the interest rate) will be based on the Eligible Issuer’s rating at the time of purchase. In addition to the principal and interest payments on the Eligible Notes, Eligible Issuers will be required to pay an origination fee equal to 10 basis points (0.10%) of the principal amount of the Eligible Notes purchased by the SPV; provided, that such issuance fee may be paid from the proceeds of the issuance. The Federal Reserve and the Treasury Department may make adjustments to the terms and conditions of the MLF through future announcements on the Federal Reserve’s website: https://www.federalreserve.gov/monetarypolicy/muni.htm.
An Eligible Issuer may use the proceeds of Eligible Notes purchased by the SPV to:
- Manage the cash flow impact of income tax deferrals resulting from the extension of the income tax filing deadline;
- Manage potential reductions of tax and other revenues or increases in expenses related to or resulting from the COVID-19 pandemic;
- Make debt service payments on the Eligible Issuer’s other obligations; and
- Purchase similar notes issued by political subdivisions and instrumentalities of the Eligible Issuer for, or otherwise assist them with, any of the foregoing purposes.
Ultimately, the Federal Reserve and the Treasury Department, through its equity investment, will bear the risk of loss on Eligible Notes purchased by the SPV. By requiring interest payments on the Eligible Notes and the payment of an origination fee, as well as limiting the amount of Eligible Notes that can be purchased by the SPV, the MLF is designed to mitigate such risk.
The SPV is not yet operational, pending further guidance from the Treasury Department and the Federal Reserve. Upon the release of such guidance, we will update this blog accordingly.
[1] As provided by the United States Census Bureau, 2017 State & Local Government Historical Datasets and Tables, as of April 6, 2020. See https://www.census.gov/data/datasets/2017/econ/local/public-use-datasets.html
