Fed opens doors to issuers for MLF program

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The Federal Reserve is now accepting letters of interest from issuers for its municipal short-note program, which suggests it won’t be long before states and local governments are able to start securing financing — if they choose to go that route.

The yet-to-be-implemented Municipal Liquidity Facility has also yet to be helpful for the market, it has a “long way to go” is “expensive” and really meant for the lowest-rated issuers as the market is already clamoring for high-grade paper, analysts said. They added that those higher-rated issuers might be better served to stick with the municipal market itself. Sources said that was the Fed’s intention when creating this program.

Florida bond finance director Ben Watkins doesn't expect his state to use the Fed's Municipal Liquidity Facility due to legal impediments and strong liquidity.

Some issuers said they may not even use it when it goes into effect in the next few weeks, according to the Government Finance Officers Association and other issuers.

Also on Friday, Sen. Bob Menendez, D-N.J., led a bipartisan group in asking Treasury Secretary Steven Mnuchin and Fed Chair Jerome Powell to create a program to further help municipalities in the medium and long term.

“Establishing a facility to purchase municipal bonds from issuers and in the secondary market across all points of the yield curve would ensure state and local governments across the country can meet their financing needs as they respond to the health crisis and lay the foundation for future economic growth,” lawmakers wrote.

The Fed released a Notice of Interest Friday morning, a form issuers must fill out to express interest in selling notes under the Fed’s Municipal Liquidity Facility.

“I perceive this as the MLF is open for business,” said Michael Decker, senior vice president of policy and research at Bond Dealers of America. “The notice of interest they specify in today’s announcement is the first step to securing financing with the facility. They are now open to accepting notices of interest, which suggest to me that it won’t be long before they approve transactions.”

As for the timing of the Fed accepting NOIs, the Fed likely wants to get a better grasp of who will be using the program, said Ben Watkins, Florida’s director of Bond Finance.

“I’m sure the facility isn’t ready, but they want to get some view of the landscape in terms of what the uptake might be, in terms of who and how much,” Watkins said.

The Fed noted in the release that issuers should submit their NOIs only when it has determined its financial needs and schedule.

Many issuers do not know what their financial needs are yet, so it is unlikely for there to be a “mad rush” to fill out NOIs for the program, Watkins said.

“It’s going to take some time for that to develop in terms of being prepared to understand what the depth of the need is — translated to dollar amount of borrowing,” Watkins said. "That will be challenging for people, I don’t think people are ready for it.”

Watkins doesn’t expect the state of Florida to participate in the MLF due to legal impediments and the state’s strong liquidity.

“We’re well-positioned in the near term through the end of June,” Watkins said. “If we continue with this shutdown and we don’t see a pretty quick snapback on the economy then that could be a different story altogether.”

Marion Gee, director of finance at the Metropolitan St. Louis Sewer District and incoming Government Finance Officers Association president, said issuers may not know immediately their need given the pandemic has lasted just about two months so far.

“Trying to really get a feel for how much you need this quickly may be difficult,” Gee said.

The state of Wisconsin, like other issuers, may also need to wait to see COVID-19’s financial impact.

“For the state of Wisconsin, we have not yet released any estimate on what this means on a revenue or budget perspective,” said David Erdman, Wisconsin’s capital finance director. “It may be a few more weeks before we’re about to do that. A lot of other issuers are in the same boat.”

However, Friday’s news shows the Fed is committed to opening up the MLF in a timely manner, Erdman said.

Dealer groups were pleased with the news, calling it a significant step.

“Today’s release of the issuer Notice of Interest form is another important milepost,” said Leslie Norwood, Securities Industry and Financial Markets Association’s managing director and associate general counsel. “The dealer community stands at the ready to facilitate where we can be helpful.”

On Friday, the Fed also announced that BLX Group LLC was designated as the administrative agent for the special purpose vehicle in the MLF purchasing the notes.

The American Securities Association noted potential conflicts of interest in choosing BLX.

“We are pleased the NY Fed is moving forward to set up the MLF, we hope its chosen advisors will acknowledge the conflicts of interest it now faces as it carries out its new role,” said Chris Iacovella, ASA CEO. “Promoting trust and confidence in our markets is paramount, especially in extraordinary circumstances such as these.”

Meanwhile, during a webinar put on by the Volcker Alliance and the Penn Institute for Urban Research on Thursday, Peter Hayes, managing director, chief investment officer and head of the municipal bond group within global fixed income at BlackRock, said "I think the [Municipal Liquidity Facility] still has a way to go before it will be utilized and help the market per se."

Hayes noted the primary market has not been functioning "anywhere close" to what it was pre-COVID, though markets have since begun recovering somewhat since the March sell-off.

The perception was that the initial announcement of the MLF program would calm markets to signal that the Fed would work as a backstop for issuers, and the second notice would be the Fed actually starting to buy securities.

“That is still not the case, we don’t know what the outcome of that will be. It hasn’t been discussed and perhaps a better-functioning market doesn’t need it to be.”

The Government Finance Officers Association's debt committee members were straw-polled after the pricing information was released this week to see whether they would use the MLF.

“There were no takers on the debt committee,” said Emily Brock, Director of GFOA’s federal liaison center. “I think though it’s because there are a fair amount of issuers who are finding capital in other ways." Brock noted that a number of the debt committee members are smaller issuers who will not benefit from the program anyway.

Indeed, issuers have been coming to market and large new-issues have been priced, albeit sometimes at a premium. Additionally, a larger number of issuers have been going directly to banks for private placements and bank loans and lines of credit, signals that issuers still have other means to access capital.

Patrick Brett, managing director and head of Citi's Municipal Debt Capital Markets and Capital Solutions businesses said the original idea of the MLF was to help with issuers’ cash-flow issues and stop those from becoming credit issues.

Rates in the MLF, compared to the rest of the market, don’t make sense for most issuers to use the program, Brett said, except for the lowest-rated issuers or issuers that need to do larger amounts of borrowing.

The program, announced in early April, will buy $500 billion of short-term notes from issuers. On Monday the Fed announced a baseline of 150 basis points for triple-A issuers to 590 points for below investment-grade-rated issuers to use the MLF — a large premium.

“Even if the facility isn’t used by those entities, I think it will be a very useful backstop for those types of entities,” Brett said.

An Illinois deal this week had similar pricing to the Fed's pricing models, Hayes noted.

Hayes said pricing in the MLF is expensive and said Illinois’ spread on its $800 million deal this week correlated with what the MLF laid out.

Illinois is rated at the lowest investment grade level of Baa3/BBB-minus with a negative outlook. Yields on its deals ranged from 4.87% to 5.85%.

In the MLF, issuers with ratings of Baa3/BBB-, spreads would be at 380 basis points and below investment grade at 590. Illinois’ spreads were pretty close to the MLF’s pricing, meaning the MLF may have priced it right, Hayes said.

“There is a lot of guesswork going into municipal pricing,” Hayes said. “In Illinois, why a spread of over 500? Because the market is extrapolating some pretty bad numbers that will occur in the state of Illinois.”

Meanwhile, Brock also discussed amendments to the MLF in the House of Representatives’ HEROES Act, which is to be voted on Friday. The bill would give $915 billion in direct federal aid to state and local governments.

Proposed changes to the MLF include extending the borrowing term from 36 months to 10 years, minimizing administrative hurdles, increasing access to issuers such as Washington D.C., and requiring borrowing at the Federal funds rate.

Lynne Funk contributed to this report.

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