The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) established an emergency lending program for state and local governments due to the COVID-19 pandemic.  This lending program, which is not yet operational, will be administered by the Board of Governors of the Federal Reserve System (the “Federal Reserve”).  To implement the program, the Federal Reserve authorized the establishment of a Municipal Liquidity Facility (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.  SPV will then purchase Eligible Notes[1] from Eligible Issuers.[2]  Additional details of the MLF are summarized in our earlier blog entitled “CARES Act Support for State and Local Governments – Municipal Liquidity Facility (“MLF Blog 1”), which can be found here. On April 27, 2020, the Federal Reserve released updated guidance for the MLF, which is summarized below.  Readers should review this summary in conjunction with MLF Blog 1.

Appointment of Administrative Agent for MLF

PFM Financial Advisors LLC (“PFM”) will serve as administrative agent for the MLF, coordinating and reviewing MLF applications based on criteria established by the Reserve Bank.

Eligible Issuers

Expansion of Pool of Eligible Issuers

The Federal Reserve’s updated guidance expands the pool of Eligible Borrowers by: (1) lowering the population thresholds for cities and counties to 250,000 and 500,000 residents, respectively,^[3] and (2) adding entities that were created by a compact between two or more states, which compact has been approved by the United States Congress, acting pursuant to its Compact Clause powers under the United States Constitution (“Multi-State Entities”).  States (i.e., each of the fifty U.S. states and the District of Columbia) still qualify as Eligible Issuers by definition.

Rounding out the categories of Eligible Issuers are entities (i.e., authorities, agencies, departments, divisions or other entities) that are statutorily authorized to issue securities on behalf of: (1) otherwise eligible states, cities, or counties or (2) the political subdivisions or other governmental entities of such eligible states, cities, or counties, for the purpose of managing their cash flows.[4]  However, such entities would only qualify as Eligible Issuers if: (i) the entities can commit the credit of, or pledge revenues of, the applicable state, city, or county, or (ii) the state, city, or county guarantees the Eligible Notes issued by such entities.  In any event, the ability of such entities to participate in the MLF would be subject to Federal Reserve review.

Although the updated guidance retains the concept of one Eligible Issuer per state, city or county, the Federal Reserve reserves the right to approve one or more additional issuers in order to expedite the flow of funds under the MLF.  To that end, the Federal Reserve is considering allowing a limited number of non-qualifying governmental entities (e.g., governmental entities that issue securities backed by their own revenues) that provide essential public services to participate directly in the MLF.

A list of Eligible Issuers based on population (other than Multi-State Entities) is provided as Appendix A to the Frequently Asked Questions released on April 27^th (the “FAQs”) at https://www.federalreserve.gov/monetarypolicy/muni.htm (the “Federal Reserve Website”).

Ratings Requirement for Eligible Issuers

To qualify for the MLF, Eligible Issuers must satisfy the following ratings requirement:

1. Eligible Issuers that are not Multi-State Entities must have been rated at least BBB-/Baa3 as of April 8, 2020 by two or more major nationally-recognized statistical rating organizations (“NRSROs”); provided, that, if such Eligible Issuer’s rating was subsequently downgraded, such Eligible Issuer must be rated at least BB-/Ba3 by two or more major NRSROs at the time of purchase of the Eligible Notes.[5]
2. An Eligible Issuer that is a Multi-State Entity must have been rated at least A-/A3 as of April 8, 2020, by two or more major NRSROs; provided, that, if such Eligible Issuer’s rating was subsequently downgraded, such Eligible Issuer must be rated at least BBB-/Baa3 by two or more major NRSROs at the time of purchase of the Eligible Notes.

Additionally, the Eligible Issuer must provide: (1) confirmation from each major NRSRO of any outstanding long-term rating of the Eligible Issuer’s obligations of the same type or source of repayment and security as the Eligible Notes and (2) evidence that the Eligible Issuer has notified such NRSROs of the issuance of the Eligible Notes.  If the Eligible Issuer does not have any such outstanding long-term rating, then it must obtain a rating on the Eligible Notes by at least two major NRSROs.

Eligible Notes

Extension of Maturity Date

The maturity date for Eligible Notes is extended from two years to three years from the date of issuance.

Debt Limit for Eligible Notes Issued by Eligible Issuers Other than Multi-State Entities

Under the MLF, Eligible Notes may be issued by an Eligible Issuer other than a Multi-State Entity in one or more issuances of up to an aggregate amount of 20% of the general revenues (income, property and sales tax revenues, for example) and utility revenues of the eligible state, city or county for fiscal year 2017.^[6]  The Federal Reserve’s calculation of such revenues for eligible states, cities, and counties, along with the methodology for such calculations, is provided in Appendix A to the FAQs on the Federal Reserve Website.  For an eligible governmental entity, the applicable revenues are those of the state, city, or county that formed the Eligible Issuer.

Debt Limit for Eligible Notes Issued by Multi-State Entities

Under the MLF, Eligible Notes issued by a Multi-State Entity may be purchased in one or more issuances of up to an aggregate amount of 20% of the Multi-State Entity’s gross revenue as reported in its audited financial statements for fiscal year 2019.

Security for Eligible Notes

Eligible Notes issued by Eligible Issuers that are not Multi-State Entities are generally expected to be: (1) general obligations of the Eligible Issuer or (2) backed by tax or other specified governmental revenues of the Eligible Issuer.  Ultimately, however, the security must be reviewed and approved by the Federal Reserve.  As noted above, if the Eligible Issuer is a governmental entity of an eligible state, city or county, then: (1) such Eligible Issuer must either commit the credit of, or pledge revenues of, the applicable state, city or county, or (2) the state, city or county must guarantee the Eligible Notes issued by such Eligible Issuer.  If the Eligible Issuer is a Multi-State Entity, then the Eligible Notes are expected to be secured on a parity basis with the Multi-State Entity’s other obligations by a senior lien on its gross or net revenues.

Pricing of Eligible Notes

Pricing for the Eligible Notes will be based on the Eligible Issuer’s long-term rating at the time of purchase and the maturity date of the Eligible Notes, plus a spread over a publicly-available benchmark or index.

Prepayment Right

Eligible Issuers may prepay Eligible Notes, in whole or in part, at any time prior to the maturity date at a prepayment price of par.  However, the Eligible Issuer’s right to prepay Eligible Notes is now subject to the approval of the Federal Reserve.

Use of Proceeds

An Eligible Issuer may use proceeds of the sale of Eligible Notes for any of the following expanded purposes:

1. Purchasing similar notes issued by the Eligible Issuer’s political subdivisions or other governmental entities[7] for, or otherwise assist them with, any of the purposes permitted by the MLF.[8]
2. Making debt service payments on not only the Eligible Issuer’s other obligations, but also the obligations of its political subdivisions and other governmental entities.
3. Paying other costs of issuance in addition to the 10 basis point origination fee.

If the Eligible Issuer uses the proceeds to purchase notes issued by a political subdivision or other governmental entity, however, the Eligible Issuer, and not the MLF, would bear the credit risk associated with such purchase.

The following purposes continue to qualify as an eligible use of proceeds under the MLF:

1. Managing the cash flow impact of income tax deferrals resulting from the extension of the income tax filing deadline.
2. Managing potential reductions of tax and other revenues or increases in expenses related to or resulting from the COVID-19 pandemic.

Extension of Termination Date for MLF

The date that the SPV will cease purchasing Eligible Notes has been extended from September 30, 2020 to December 31, 2020, subject to further extension by the Federal Reserve and the U.S. Treasury Department.

Closing Conditions and Other Considerations

In addition to legal opinions and other disclosures as may be required by the Federal Reserve, each Eligible Issuer must certify in writing that it is unable to secure adequate credit accommodations from other banking institutions and that it is not insolvent.  In making this certification, Eligible Issuers may consider current economic or market conditions as compared to normal conditions, which may include the availability and price of credit or other factors.

In evaluating the closing conditions and other requirements of the MLF, Eligible Issuers should consult their attorneys regarding the constitutional and statutory requirements governing the Eligible Issuer, its issuance of debt and the use of the proceeds thereof.

[1] Eligible Notes consist of newly-issued tax anticipation notes, tax and revenue anticipation notes, bond anticipation notes, and other short-term notes that mature no later than three years (up from two years) from the issuance date.

 [2] As originally announced by the Federal Reserve, Eligible Issuers for the MLF included: (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 securities on behalf of any of the foregoing entities for the purpose of managing its cash flows.  This list has been adjusted as further described in this blog.

 [3]The initial population thresholds were one million residents for cities and two million residents for counties.

 [4] In a change from its previous announcement regarding the MLF, the Federal Reserve now uses the term “entity” instead of “instrumentality” throughout its term sheet outlining the MLF.

[5] The NRSROs are currently S&P Global Ratings, Moody’s Investors Service and Fitch Ratings, but the Federal Reserve is considering expanding this list to include other rating agencies.

[6] 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

[7] Previously, this eligible use of proceeds referenced “instrumentalities” as opposed to “governmental entities.”  For purposes of this eligible use, the Federal Reserve broadly defines a “political subdivision or other governmental entity” as any county, city, municipality, township, village, school district, special district, utility, authority, agency or other unit of government, as determined by the Eligible Issuer; provided, that such political subdivision or other governmental entity is not insolvent.

[8] This permitted use is limited to Eligible Issuers that are not Multi-State Entities.