MLF price reductions unlikely to cause widespread issuer participation
The Federal Reserve’s move to lower interest rates for its short-term municipal note purchase program isn't likely to impact most issuers' calculus in deciding whether or not to access it.
Tuesday night, the Fed reduced interest rates of its Municipal Liquidity Facility in each credit category by 50 basis points. The reduced interest rates are still not attractive to the vast majority of issuers, and that isn't likely to change unless the Fed moves the rates again or market conditions change significantly.
“I would say there are some (issuers) seriously looking at it and have been for quite some time, I don’t get the sense that there will be a mass rush for it because pricing has been so favorable that those that needed to get deals done were able to price it in the market,” said Emily Brock, director of the Government Finance Officers Association’s federal liaison center.
Market rates have been incredibly low. Last week the Bond Buyer Index 20 year maturity for general obligation bonds was 2.02%. The Fed’s new interest rates are still higher than an investment-grade issuer would pay in the capital markets.
The revised pricing reduces the interest rate spread on tax-exempt notes for each credit rating category by 50 basis points and reduces the amount by which the interest rate for taxable notes is adjusted relative to tax-exempt notes.
The Fed changed its pricing to a baseline of 100 basis points for triple-A rated issuers to 540 basis points for below investment-grade-rated issuers.
The Fed launched the MLF in accordance part of the CARES Act, a coronavirus relief package that was enacted in March. The MLF opened its doors in May. Illinois has been the only issuer to use it so far. The Fed has said the MLF pricing was meant to be used as a backstop for borrowers.
For issuers considering short-term borrowing options, the Fed’s news makes the MLF more attractive, Brock said. That could mean issuers hit hard by the pandemic such as revenue bond issuers like transit systems may get on board. Brock said those issuers may be some of the first to use the program.
If markets change and as sales tax and property tax collections get stressed, the MLF could become more attractive for issuers, Brock said.
The muni market has rallied since March, and Michael Decker, senior vice president of policy and research at Bond Dealers of America, noted that rates have come down in the last month by 20 to 25 basis points for some maturities.
The MLF is open to counties with populations of 500,000 or more and cities of 250,000 or more. In June, the central bank allowed U.S. states to be able to have at least two cities or counties eligible to directly issue notes regardless of population. Governors of each state are also now able to designate two issuers whose revenues are derived from activities such as public transit and tolls.
“The program is still very narrowly targeted, so only a few hundred issuers get direct access,” Decker said.
The Fed is likely to continue making adjustments to the MLF’s rates over time as the market changes and the Fed’s experience with the program changes, Decker said.
“It won’t be unusual if the Fed comes out with another announcement later that reduces rates again,” Decker said. The Fed could be tracking the municipal market and wanted to keep the rated in proportion to those in capital markets, he added.
Issuers still won’t use the MLF, even though the New York Metropolitan Transportation Authority may be eyeing it, said Brian Battle, director of trading at Performance Trust Capital Partners, since they borrow often and are facing budget and deficit issues.
“So we’ll see if these rates will entice the MTA, but the MTA still has market access,” Battle said.
The new prices set a ceiling for interest rates in the muni market, but they are still far from where the muni market is. That could change in a period of distress, Battle said.
Democratic lawmakers called for the Fed to reduce its pricing in the MLF, and that could have played into the Fed’s decision, Battle said.
“The pressure on the Fed must be enormous for them to make this sort of public adjustment,” Battle said. “They acknowledged that they should make the utility greater by lowering the rates, but the net effect is, the rates are still high enough that it doesn’t look like anyone will use it.”