State Treasurer Determines Municipal Liquidity Facility Not in Best Interest of Washington

Legislative Building

Olympia, WA — The COVID-19 crisis has put a financial strain on our state and nation that is unprecedented in modern times. As we work to navigate this new era, the Office of the State Treasurer (OST) has spent considerable effort analyzing strategies that might be available to address the financial challenges facing the State of Washington and our local governments. The most notable structure to date is the $500 billion Municipal Liquidity Facility (MLF), which the Federal Reserve (Fed) announced on April 9, 2020, as part of the $2.3 trillion CARES Act.

While certain aspects of the program have appeal, the MLF as currently structured will not directly benefit the state. Most importantly, as a short-term loan program and not a source of direct aid, borrowing through the MLF, or public markets for that matter, to fund cash-flow needs places a severe burden on future budgets when repayment will be due. Borrowing to cover lost revenue is a strategy akin to “kicking the can down the road” that could have a disastrous impact 12 to 36 months from now when the loan must be repaid, and when the state will likely still be recovering from the COVID-19 financial crisis.

“In addition to not being a substitute for direct aid, the program’s above market “penalty rate” makes the MLF a non-starter for the state and, frankly, for all highly-rated municipalities across the country,” said Treasurer Davidson.

OST staff has calculated that based on the Fed’s pricing formula released May 11, 2020, the current market interest rate for a MLF loan would be between 2.3 and 2.8 times higher than the comparable interest rate for a loan obtained through the traditional municipal bond market. As such, based on market conditions as of today, the MLF would not provide any cost savings to the state. Furthermore, based on the availability of lower interest rates in the public market, OST would not be able to sign-off on the Fed’s required certification that adequate lending was not available from other banking institutions, effectively precluding the state from using the program.

Program Overview:

The MLF is a direct lending program where the facility will purchase up to $500 billion of short-term notes from states and other eligible municipalities. Proceeds from the sale of notes can be used by eligible participants to manage cash flows impacted by tax or revenue deferrals, to cover increases in expenses due to the COVID-19 pandemic, to pay debt service on currently outstanding debt, or to purchase similar notes issued by political subdivisions or other governmental entities to help them manage their cash flows.

As indicated in the Fed’s term sheets, participation in the MLF is limited to Eligible Issuers, which are all 50 U.S. states, cities with populations greater than 250,000 residents, and counties with populations greater than 500,000 residents. Within Washington, there are six eligible issuers: the state, Seattle, and King, Pierce, Snohomish, and Spokane counties.

In terms of structure, notes purchased by the MLF must be short-term anticipation notes, with a final maturity of 36 months or less from the date of issuance. Anticipation notes, such as TANs, TRANs, BANs, and other similar structures, are typically issued by state and local governments to meet temporary financial needs. Issuers are limited to an aggregate amount of no more than 20% of the general revenue from “own sources and utility revenue” for fiscal year 2017. The Fed has indicated that the source of repayment and security should be generally consistent with the strongest security typically used to pledge and repay obligations offered by each issuer. The deadline for issuing notes through the MLF is December 31, 2020.

On April 27, 2020 and on May 11, 2020 the Fed provided additional guidance in the form of updated term sheets, FAQs, and detailed pricing information. Most importantly, the Fed has specified that the notes will be a priced at a penalty rate. Additionally, issuers must certify that they cannot secure adequate credit accommodations from other banking institutions at prices or on conditions that are consistent with a normally well-functioning market.

The Fed’s FAQs also clarified that governmental entities, that are not Eligible Issuers, 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. However, the Eligible Issuer would bear the credit risk and be fully responsible for guaranteeing the repayment of any notes that it purchased from its political subdivisions or other governmental entities.

“It is important to recognize that even if we get past the risks of borrowing to cover a deficit and the above market interest rates of the program, extending the MLF to local governments presents a significant risk to the state as such an action would place additional pressure on our credit ratings and constitutional debt limit,” said Treasurer Davidson.

While the MLF in its current form as a lender of last resort helped to provide some confidence to the municipal bond market, it is clear that eligible borrowers with solid credit ratings have lower-cost borrowing options available to them. OST will continue to monitor the MLF and any other proposals brought forward as the situation develops. However, we anticipate that the financial impact of this crisis will not be limited only to fiscal year 2020. As such, without direct federal aid, traditional budget management tools, especially budgetary cuts, will be the most appropriate strategy for addressing the COVID-19 financial crisis, with borrowing serving as a last resort.


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