The Federal Reserve just announced a new Municipal Lending Facility targeted to specific state and local governments. The facility will buy up to $500 billion of short-term notes directly from states and local governments. Only cities with a population of at least one million residents and counties with a population of at least two million will be eligible. States may also use the proceeds to provide additional support to their local governments in need, regardless of population size.
In order to fund the facility, the Fed will commit their lending through a special purpose vehicle (SPV) with the Treasury providing an initial injection of $35 billion. The types of securities eligible include tax anticipation notes, bond anticipation notes, and revenue anticipation notes that have maturities less than two years. Participating issuers in the SPV will be required to pay an origination fee of 10 basis points which can be included in the bond’s proceeds.
Issuers may use the proceeds provided by the SPV to pay principal and interest on their outstanding obligations, for cash flow management with respect to increased expenses and/or loss of revenues related to the COVID-19 pandemic, or for higher level governments to purchase similar short-term notes from local municipalities.
Funding levels will be limited to 20% of the municipality’s general revenues or utility revenues from fiscal year 2017 and the securities will be continuously callable at par. Pricing will be based on the issuers credit rating with further details to be provided later.
The biggest question here is the trickle down aid at the local level. States will need to identify local municipalities that are hardest hit by the pandemic and allocate resources accordingly. This, in addition to other stimulus measures of the CARES Act, will provide much needed relief to the sector.
For now, the market’s reaction to the news is positive with yields on the AAA MMD curve about 1 – 7 basis points lower from yesterday. The high yield market is also rallying on the news that the Fed plans to start buying bonds recently downgraded to below investment grade. We’ll continue to monitor this fluid situation and provide ongoing updates as the Municipal Lending Facility moves forward.
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