Municipal market participants are giving positive reviews to the Federal Reserve’s Monday announcement that it will expand its short-term municipal note purchasing program, saying the Fed’s decision and accompanying guidance will improve the program and provide more certainty to municipal issuers.
Groups representing dealer firms and issuers both hailed the Fed’s decision to expand its Municipal Liquidity Facility in both scope and duration, covering smaller issuers and operating for three extra months. The Fed announced April 9 it would purchase up to $500 billion of short-term muni debt from states, counties with a population of at least two million residents, and cities with a population of at least one million residents. The changes announced Monday now allow the program to cover counties of 500,000 or more and cities of 250,000 or more.
“Broadening the universe of issuers who may access the program directly, lengthening the maximum maturity, and extending the termination date will all make the program more accessible and successful,” Bond Dealers of America said in a statement.
Emily Brock, director of the federal liaison center at the Government Finance Officers Association, said GFOA was very excited by the MLF expansion and reassured by some of the clarifications provided in an “FAQ” document released simultaneously with the expansion announcement.
The American Securities Association, initially a critic of the Fed’s “arbitrary” population parameters, also applauded the new version of the program.
“ASA has been working with the Fed and members of Congress to ensure a greater share of America’s municipalities have access to financing during this time, and today’s action is a good start that will begin to help some Main Street communities,” said ASA CEO Chris Iacovella. “We applaud the Fed for being open-minded as it continues to structure these new and unprecedented liquidity and credit facilities.”
The MLF is now scheduled to operate through Dec. 31, extended from an original Sept. 30 termination date. The scope of eligible notes also grew because the Fed expanded the maximum maturity of eligible securities to 36 months from the previously announced 24-month maximum term. It also introduced a provision allowing eligible issuers that had an investment-grade rating from two of the three largest credit rating agencies as of April 8 to participate in the MLF even if they have since lost that rating.
The ratings criteria for the MLF refer to ratings provided by S&P Global Ratings, Moody’s Investors Service, or Fitch Ratings, but the Fed said it is considering expanding the list of agencies. Cities, states, and counties must still be rated BB-minus or Ba3 at the time the Fed makes a purchase.
The FAQ document provided by the Fed hinted at the possibility that the not-yet operational program might be further expanded to include other types of issuers that provide essential public services and issue bonds backed by their own revenue.
“Other governmental entities that provide essential public services on behalf of a state, city, or county may participate in the MLF indirectly by borrowing through an eligible state, city, or county,” the Fed explained. “The Federal Reserve is also considering expanding the facility to allow a limited number of such entities to participate directly in the MLF as eligible issuers, taking into consideration the objective of quickly and efficiently making the facility available to the currently defined set of eligible issuers."
The FAQ also made clear the MLF does not assume the credit risk that would be associated with an issuer’s decision to use the proceeds from its participation in the MLF to purchase the eligible notes of its political subdivisions, which is something muni market participants had been hoping the Fed would accept.
“Regardless of the use of proceeds, the facility (and any other holder of the eligible notes) faces only the credit of the eligible issuer,” the Fed said in the FAQ. “The eligible issuer would bear the credit risk associated with any notes it purchased from its political subdivision or other governmental entity.”
BDA, which has called for the Fed to assume the credit risk in such cases, said it continues to hope the Fed will do so going forward.
“We continue to urge the Fed to explicitly assume the credit risk associated with ‘downstream’ state and local governments who will need to access the facility through their states even after today's announcement,” BDA said.
Brock said the Fed’s explanation of the risk allocation was still helpful, even if it was not what many in the market were hoping for, because it at least allows for issuers to make an appropriate assessment of risk.
“This makes it clear,” she said.
The Fed said it would announce any changes to the program at a future date, and is continuing to keep an eye on market conditions. In recent weeks the Fed has staffed up on its muni knowledge, hiring former muni banker and U.S. Treasury official Kent Hiteshew in March and borrowing the expertise of Municipal Securities Rulemaking Board Chief Market Structure Officer John Bagley beginning this week.
“The Federal Reserve will continue to closely monitor conditions in primary and secondary markets for municipal securities and will evaluate whether additional measures are needed to support the flow of credit and liquidity to state and local governments,” the Fed said.
