Illinois cuts final check to repay Fed's MLF loan

Illinois paid off the remaining $302 million owed to the U.S. Department of Treasury on a $2.175 billion Federal Reserve Municipal Liquidity Facility loan due in December 2023.

Paying off the loan early will shave about $82 million off the interest tab.

“With this early repayment, we take another important step toward restoring fiscal stability and predictability to Illinois,” state Comptroller Mendoza, whose office manages state bill payment, said in a statement.

Gov. J.B. Pritzker, Mendoza and legislative leaders in May announced plans to tap higher-than-expected state tax revenues to pay off the loan by the end of fiscal 2022 on June 30.

The state became the first to tap the program enacted to help calm markets rattled by worries over the growing COVID-19 pandemic’s economic blows government revenues when it borrowed $1.2 billion through a one-year loan in June 2020 that was repaid by the close of fiscal 2021.

The state originally intended to pay down the second loan taken out in December 2020 with funds officials were banking from a potential federal stimulus package that at the time had stalled. The federal government eventually passed a new aid package — the American Rescue Plan Act — in March 2021 sending $8 billion to Illinois.

The Department of Treasury threw a wrench in repayment prospects when the initial guidance issued in May that year barred the use of ARPA aid for debt repayment. The state lobbied for a change in a letter to Treasury Secretary Janet Yellen. But as state tax collections turned rosier, state leaders opted instead to cover repayment with tax collections.

Mendoza paid off about half of the $2 billion loan in the last fiscal year stressing that no federal aid was used. Much of the second loan’s proceeds went to pay down medical bills racked up during the pandemic, which in turn allowed the state to leverage more federal matching dollars. The backlog is down to about $3.8 billion and the state is paying its bills within 15 business days, the quickest payment cycle in over 20 years, Mendoza said.

The state’s management through the pandemic, the infusion of federal aid, and rising tax collections helped win rating upgrades in June from Moody’s Investors Service and S&P Global Ratings that moved the state’s rating two notches away from a speculative grade. Fitch Ratings raised the outlook on the state’s BBB-minus rating to positive from negative also in June and more recently S&P lifted the state’s outlook to positive.

While the MLF's rates were high by municipal market standards, it provided a backstop for borrowers who might otherwise struggle with affordable market access. The Coronavirus Aid, Relief, and Economic Security Act signed March 27, 2020 provided authority for the program, allowing for up to three-year loans. The program ended at the close of 2020.

The state initially intended to competitively sell one-year certificates for cash-flow purposes in May 2020, 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.

The state opted instead to go with the MLF paying a 3.82% rate on the first loan that closed in June 2020. Rates were set by a base tied to the overnight swap index plus a spread set by the state’s ratings.

Refinitiv MMD at the time set the state’s one-year rate at a 345 basis point spread to the AAA benchmark, down from highs of 365 basis points to 400 basis points over the prior week.

At the time, market participants said Illinois served as an ideal candidate for the program’s purpose and called the state’s decision wise.

The first borrowing “provided the sense that the state now had adequate liquidity to weather any shortfall in tax revenues they might experience from the pandemic because the greatest risk is that a government will run out of money so that calmed the market’s concerns,” said Richard Ciccarone, president of Merritt Research Services.

The state’s fiscal 2021 budget authorized up to $5 billion of additional borrowing and the state decided to tap $2 billion in December 2020 as efforts to pass a new relief package were stalled. The state had access to up to $9.7 billion under the federal program guidelines.

The Federal Reserve earlier had shaved loan rates by 50 basis points so the state paid 3.42% on its second loan.

Some market participants questioned the state’s decision to go with the program for a second loan as its spreads by then had narrowed. Few questioned the state’s market access at lower rates, but the program still offered benefits.

Use of the program eliminated any risk of a “surprise,” Ciccarone said. “The state might have been willing to pay a little more for the certainty” based on the rate and lack of early pay off penalties.

A Federal Reserve Bank of Chicago December 2020 letter, “The Impact of the Pandemic and the Fed’s Muni Program on Illinois Muni Yields”“The Impact of the Pandemic and the Fed’s Muni Program on Illinois Muni Yields”“The Impact of the Pandemic and the Fed’s Muni Program on Illinois Muni Yields” looked at the spike in municipal bond yields early in the pandemic and the state’s use of the MLF.

“The acceleration of the pandemic in mid-March had the potential to generate severe upward pressure on municipal bond yields for many state and local governments,” the letter read. “According to our estimates, the MLF appears to have reduced Illinois muni yields by more than 200 bps, thus helping to alleviate some of the budgetary pressures. In all, our results suggest that the MLF has been a helpful addition to the Fed policy toolkit."