What Is the Municipal Liquidity Facility?

There is no question that COVID-19 has had a major impact on state and local governments’ revenue and expenses. To what extent it will impact any particular governmental unit will vary depending on its mix of revenue sources. In an effort to address state and local cash flow pressures and tax revenue shortfalls, the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and the U.S. Treasury established the Municipal Liquidity Facility (the “Facility”). The Facility’s purpose is to support credit and liquidity flow to state and local governments by providing short-term financing to certain governmental issuers. The Facility has the ability to purchase up to $500 billion of debt from impacted state and local governments. The Facility also monitors conditions in the primary and secondary markets for municipal securities in order to determine if any additional action will be necessary. 

Under the Facility, the Federal Reserve purchases short-term municipal notes issued by the states, the District of Columbia, eligible local governments, and Multi-State Entities. Eligible issuers must pay an origination fee of 10 basis points on the principal amount of notes purchased by the Facility. Notes purchased by the Facility may be called by the issuer at par any time before maturity. Unless extended, the Facility will cease buying notes after December 31, 2020. The Facility will be funded until its assets mature or are sold. Through this special purpose vehicle, the U.S. Department of the Treasury will provide $35 billion in initial equity to the program from its Exchange Stabilization Fund, as appropriated under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The remaining funding, up to $465 billion, will come from the twelve regional Federal Reserve Banks.

Eligible local governments include counties with populations of at least 500,000 people, and cities with populations of at least 250,000. In addition, smaller states were given the option to designate a certain number of cities and/or counties to be eligible for the program, even if that city and/or county did not otherwise meet the population requirement. The number of allowed designations depends on the state's size, but the maximum was two designations. As both Maine and New Hampshire were considered to be smaller states, both governors were given the ability to designate a total of two cities and/or counties. Governors that have the ability to designate two Designated Cities and Designated Counties (on a combined basis) may choose any of the following combinations: (i) the most populous city and most populous county; (ii) the most populous city and second-most populous city; or (iii) the most populous county and second-most populous county. Massachusetts was not given the ability to designate any cities or counties based on its size.

In addition, state governors also can designate two "Revenue Bond Issuers" whose revenues are generally derived from operating government activities, such as utilities or airports, that could also sell bonds to the Facility. The municipal debt instruments eligible for purchase by the facility include tax anticipation notes (TANs), revenue anticipation notes (RANs), and bond anticipation notes (BANs), as well as other similar notes. Additionally, eligible debt securities must have terms to maturity of no more than 36 months from their dates of issuance. A given state, county, or city may have multiple entities, authorities, or instrumentalities that issue debt on its behalf. However, the Facility will limit itself to purchasing notes issued by only one issuer per state, county, or city. The Facility also will limit its purchases of notes from a given state, county, or city to an amount equal to 20% of its general revenues during its 2017 fiscal year. However, states may apply for exceptions under which the facility will buy notes in excess of these limits. The Facility is limited to 20% of a Multi-State Entity or Revenue Bond Issuer's gross revenue for fiscal year 2019.

In order to reap the benefits of this program, your municipality must meet the above eligibility requirements or have been specifically designated by the governor of your state as a Designated City or County. While the Facility is limited in eligibility scope and only aimed at new issuance, not secondary market purchases, the establishment of this program generated a positive response in the municipal bond market almost immediately upon its creation.

New Governor, New Era for State/Municipal Partnership

Governor Janet T. Mills is being inaugurated today as Maine’s first female Governor. Municipal officials and leaders throughout the state should expect a more positive relationship between the Governor and the State of Maine and local municipal government during this new administration. As everyone is well aware, despite having been the former Mayor of Waterville, Governor Paul LePage had a very testy and unproductive relationship with municipalities throughout his tenure as Governor. He was generally opposed to revenue sharing for municipalities and went out of his way to foist responsibility onto municipalities for programs and the costs of those programs for which the State historically has taken responsibility. Governor Mills, in her interview with the Maine Municipal Association which occurred prior to the election, made it abundantly clear that she welcomes the support and advice of municipalities and fully intends to restore that relationship and stop the process of shunting costs onto local property tax payers. Since Governor Mills worked her way up through the ranks of local and state politics before becoming Attorney General and finally Governor, she has a keen understanding of what local officials go through and will likely be far more sensitive to those concerns than the previous administration.

Let's Talk Municipal Finance - Issuing Bonds

In my previous installment, I discussed several financing alternatives available to municipalities and certain other governmental entities to supplement revenues from their tax base or user fees. One common option is the issuance of bonds, either independently, or through a pooled issuance. 

The Issuance of Bonds

The first step to issuing a bond is the approval process at the local level.  The process varies depending on the municipality or governmental entity’s charter, enabling statutes, and other protocols that may be applicable to the issuer. It may require a formal recommendation from the governing officers followed by a vote of approval at a meeting of the residents of a municipality, or an approval only from the governing  body of a governmental entity.  Municipalities should note that their ability to incur debt is not unlimited.  For example, municipal debt it is capped by statute at an aggregate of 7.5% of the municipality’s last full state valuation, subject to certain exceptions for, by way of example, debt incurred for school purposes, storm or sanitary sewer purposes or for energy facility purposes.  Certain bonds, such as those for school purposes, may be funded primarily through payments from the state rather than from tax revenues at the local level.

Independent vs. Pooled Issuance

A municipality or governmental entity may choose to issue bonds completely on its own or through a pooled issuance, such as those with the Maine Municipal Bond Bank or New Hampshire Municipal Bond Bank. Bonds issued independently are done so via either a “directed sale” using a financial adviser or a “negotiated sale” using an underwriter.  The use of a pooled issuance, however, can help decrease costs and achieve a higher credit rating, which translates to lower interest rates.  According to the Maine Municipal Bond Bank, while the average cost of an individual municipality’s issuing a bond on its own would be approximately $15,000-18,000, a pooled issuance costs a municipality only about $2500 to $5000 (the cost of local bond counsel).  

Following a pooled issuance, however, the municipality is subject to on-going administrative fees while the bond is outstanding, which are not incurred by the municipality if it chooses to issue the bonds independently. If the municipality or governmental entity chooses to issue bonds using a pooled issuance, it must go through an application and approval process with the entity facilitating the pooled issuance and, if approved, follow the issuance schedule of the facilitating body, which often limits the number of issuances each year.

Regardless of whether a municipality or governmental entity decides to issue bonds independently or as part of a pooled issuance, it is subject to certain obligations following the issuance of the bonds until their maturity date. These obligations include, in the case of tax-exempt bonds, adopting a post-issuance compliance policy intended to maintain the tax-exempt nature of the interest on the bonds.  The municipality or governmental entity may also be required to enter into a continuing disclosure agreement or continuing disclosure certificate, which require the issuer to comply with certain Securities and Exchange Commission reporting requirements.

In my next installment in this series, I will discuss anticipation notes, which are commonly issued directly through a bank.  Anticipation notes are a short-term financing alternative used in anticipation of upcoming bond proceeds or tax revenues.

Let's Talk Municipal Finance – An Introduction

This is the first in a series of posts discussing financing alternatives available to municipalities and certain other governmental entities, such as school, water, and sewer districts. 

Municipalities and other governmental entities throughout Maine and New Hampshire are primarily dependent on real estate tax revenues to finance their municipal projects, however, at times the cost of a certain project may require a lump sum of capital that exceeds revenues. When such a situation arises, those entities may choose to borrow money, which is then repaid over time from tax or other revenues.

For long-term financing, municipalities and other governmental entities frequently issue bonds, either on their own or through a pooled issuance, such as those with the Maine Municipal Bond Bank, the New Hampshire Municipal Bond Bank or the United States Department of Agriculture. Generally speaking, there are two types of bonds – general obligation bonds and revenue bonds. Although municipalities may issue either type of bond, they most frequently issue general obligation bonds, which are payable from the general tax revenues of the municipality. On the other hand, other governmental entities usually issue revenue bonds, which are payable only from the revenues of the specific issuer. For example, an airport that issues a revenue bond to construct a new runway may only use revenues from the airport’s operations to repay the bond, rather than the general tax revenues of the municipality where it is located.

At times, a municipality or governmental entity may not be able to wait until a long-term bond can be issued or annual tax revenues are collected. In that case, they may turn to bond anticipation notes or tax anticipation notes obtained directly through a bank, each of which serve as interim financing until funds can be raised either through a full bond offering or from tax revenues. In other cases, a municipality or governmental entity may choose to avoid debt financing altogether through the use of a municipal lease purchase agreement for new equipment, which is similar to a lease-to-own agreement.

In our next installment in this series, we will discuss the bond application and issuance process and in later installments, other forms of financing such as anticipation notes and municipal lease purchase agreements.