Illinois is first to use Fed MLF program in $1.2 billion deal

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Illinois will borrow $1.2 billion of one-year, general obligation backed notes through the Federal Reserve’s Municipal Liquidity Facility, Gov. J.B. Pritzker’s administration announced Tuesday.

It is the first municipal issuer to use the up to $500 billion lending program the Federal Reserve and U.S. Treasury announced in April as the economy shuddered under the impact of the coronavirus and the shut-down actions taken to slow its spread.

Illinois will pay 3.82%, the Pritzker adminitration said.

While the MLF's rates are high by municipal market standards, it provides a backstop for borrowers who might otherwise struggle with affordable market access. The Coronavirus Aid, Relief, and Economic Security Act signed March 27 provided authority for the program.

The proceeds will help bolster state liquidity and offset a portion of the tax hit from the COVID-19-driven economic shutdown and the state’s income tax filing extension to July. The issue is expected to close June 5, according to state officials.

Illinois Tuesday announced that it is the first to tap the Federal Reserve's Municipal Liquidity Facility with a $1.2 billion deal.

Pritzker first announced the one-year certificate issue in April as part of the administration’s plan to close a $2.7 billion revenue gap in the current fiscal 2020 budget that runs through June 30. Under short-term bond statutes, the state can borrow to cover a shortfall in forecasted revenues but must repay the debt in the following fiscal year.

The state entered an agreement with the special purpose entity on the sale Tuesday.

“The Federal Reserve Bank worked closely with our team to make this transaction possible through the Municipal Liquidity Facility, which is an important tool the state is using to answer the unprecedented economic challenges posed by the COVID-19 pandemic," Alexis Sturm, director of the Governor's Office of Management and Budget, said in a statement.

The rate of 3.82% is based on MLF pricing guidance that includes a base tied to the overnight swap index and a spread based on an issuer’s ratings. In Illinois’ case, the spread is 380 basis points. The New York Fed put out a pricing guidance as of June 1 that put a borrower rated at the lowest investment grade level like Illinois — BBB-minus across the board — at 3.83%.

The state’s one-year bond was set Tuesday by Municipal Market Data at 345 basis points to the AAA benchmark, down from 365 bps Monday and 400 bps last week.

Use of the MLF provided the best option for the state, said Brian Battle, director of trading at Performance Trust Capital Partners. “The MLF has massive size, is one non-economic buyer [with pricing set], has clear credit stipulations and is tasked with making these exact type of loans in their goals,” said Battle, who in May predicted the state would find a way to tap into the program after moving the sale to the day-to-day calendar.

The state initially intended to competitively sell the certificates in May but ongoing market turmoil put the deal on the shelf. The decision came as the market was showing a preference for stronger credits and the state faced grim headlines that threatened its investment-grade ratings. That, in turn, drove up secondary market trading spreads to peak levels.

At the time the state’s one-year was set at 3.73%, a 296 basis point spread to MMD top benchmark. Market participants said they expected the market to price the notes at a much higher interest rate. The one-year maturity in the 25-year long term bond sale that came a week later landed at a 4.875% yield for a 433 bp spread to the AAA scale.

As guidelines on eligibility, pricing, and the sale process were fleshed out, many market participants called Illinois an ideal candidate, but the state’s required competitive bidding process remained a sticking point that precluded the state’s participation.

Both the MLF and Illinois have since changed their rules, with the Pritzker administration winning legislative approval in late May to amend the short-term borrowing act to forgo the competitive sale requirement and sell directly to the MLF for fiscal 2020 and 2021.

The changes were part of a larger package that give the state authority to tap up to $5 billion of borrowing through the MLF to manage fiscal 2021 revenue strains. The state has access to up to $9.7 billion under the federal program guidelines.

The fiscal 2021 general fund budget relies on up to $5 billion of MLF borrowing.

The legislation allows the state an up to 10-year term although the Fed's current MLF rules limit the term to 36 months.

The state is hoping to avoid or limit use of the program for fiscal 2021 by winning federal relief to make up for lost revenues.

The state’s spreads have narrowed in recent days from peak levels. Bonds six years are out were set at a 367 bp spread to the AAA Tuesday. That’s improved over a 387 bp spread Monday, 417 bps at the end of last week and a peak level of 425 bps early last week.

Chapman and Cutler LLP and Burke, Burns & Pinelli were co-bond counsel and Public Resources Advisory Group advised the state.

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