Market participants want more municipalities to be allowed to participate in the Federal Reserve’s short-term municipal lending program.
Groups communicated that in letters sent to the Fed this week. The Fed solicited feedback through April 16 on its Municipal Liquidity Facility program, and sources say the Fed is putting together a frequently asked questions document about the program.
In letters sent to the Fed on Wednesday, the Bond Dealers of America and Government Finance Officers Association made a few recommendations to the Fed — one being to increase the scope of the program. Through the MLF, the Fed will purchase up to $500 billion of short-term notes, with Treasury providing $35 billion of credit protection to the Fed using funds appropriated in the $2 trillion Coronavirus Aid, Relief and Economic Security Act.
“Unfortunately, the cut-off for direct issuer participation is much too high,” wrote Mike Nicholas, BDA CEO. “By our calculation, only 24 local governments nationwide would qualify for direct access to the Fed program. This would leave tens of thousands of local governments and authorities unable to access the facility directly.”
The Fed said it would buy notes directly from states, counties with a population of at least two million residents, and cities with a population of at least one million residents. Only one issuer per state or county is eligible. State-level issuers can use the proceeds to support additional counties and cities.
BDA said some states may be legally or constitutionally prohibited from serving as a conduit to local governments and said some states may have statutory limits to how much debt they can incur.
In a separate letter, the Government Finance Officers Association also noted that states have unique issues that may impair their ability to be the sole issuer, since the program only allows for one issue per state, city or county.
“Each state has unique constitutional issues that may impair their ability to meet this requirement; in other words, the credit for a bond bank type entity that addresses the needs of subdivisions and instrumentalities within the state’s border may need to be different and separate from the state’s credit,” wrote Emily Brock, director of GFOA’s federal liaison center.
BDA and GFOA did not provide specific recommendations on how the Fed should make the program more inclusive, but other groups representing dealers and issuers have also said too few municipalities are eligible for direct support under the program.
BDA and GFOA are also urging the Fed to protect states from losses from their local government counterparts.
“To the extent that states are the conduit for local government access to the MLF, it is vital that the Fed explicitly indemnify states from losses associated with defaults and other credit events by the ‘downstream’ local borrowers who will access the facility through their state governments,” Nicholas wrote.
States are not in a position to absorb default losses, Nicholas said, adding that failing to explicitly indemnify states would run counter to the intent of the program since its aim is to support the market by taking on short-term credit risk.
Michael Decker, BDA's senior vice president of policy and research, said his group wants the Fed to take on the credit risk.
Brock said it can be a challenge for states to set up financing for their local governments.
“It also brings to the forefront for states that have never issued on the behalf of a local jurisdiction within them, they’re taking on a risk they never have taken on before,” Brock said. “They have to assess that risk, they have to insure that risk. Because the Federal Reserve set up this program, we’re asking that somehow the Federal Reserve provide assurances so that risk isn’t borne by the state.”
BDA also wants the Fed to limit documentation and disclosure associated with the MLF.
“In order to streamline participation in the program to a significant degree, we urge the Fed to require as little documentation and disclosure as possible while still protecting the Fed’s interests in the transactions,” Nicholas wrote. “We do not believe, for example, that filing financial statements as a prerequisite for accessing the facility is necessary.”
Rather, BDA would prefer issuers to satisfy any requirements with representations that they will abide by the rules of the program.
GFOA asked that disclosures not extend beyond what issuers are required to provide in their continuing disclosure agreements.
BDA and GFOA also want the Fed to base pricing of the notes on widely used benchmarks.
Last, both groups want the Fed to specify the costs of issuance that can be paid by issuers from the proceeds of borrowing through the MLF. Issuers typically use a portion of bond proceeds to pay legal and advisory fees associated with the issuance. GFOA said issuers are likely to assume costs for issuing debt and asks the Fed to consider guidance that they be paid through the proceeds of borrowing.
GFOA suggested to the Fed that the termination date of the program be extended to Dec. 31. It currently ends on Sept. 30. GFOA says states may require legislative action and face administrative hurdles. GFOA said states and local governments will face tax collection delays and may not be able to fully assess the extent of their liquidity needs.
BDA wrote a letter to the Fed last week proposing a municipal note guarantee program, but said the MLF being implemented as proposed eliminates the need for such a guarantee.
