Yale School of Management

Program on Financial Stability

Improving our understanding and management of systemic risk.

Federal Reserve Lowers Pricing for Municipal Liquidity Facility

August 19, 2020
: By Natalie Leonard

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The Federal Reserve Board announced August 10 that it would revise pricing for the Municipal Liquidity Facility (MLF). Specifically, the updated term sheet includes a reduction in the interest rate on MLF loans of 50 basis points across all credit rating categories. The Fed also revised the relationship between interest rates for tax-exempt notes and for taxable notes. 

The Fed created the Municipal Liquidity Facility under the authority of Section 13(3) of the Federal Reserve Act. The Treasury, under the authority of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, has made a $35 billion equity investment in the facility. Read more about the MLF here.

The Fed announced in April that the MLF could lend up to $500 billion to eligible states, counties, and cities. As of yet, though, it has only extended a single one-year loan of $1.25 billion, priced at 3.82%, to the state of Illinois. New Jersey reportedly is also considering requesting a loan through the facility. 

Soon after the Fed launched the facility, a progressive advocacy group criticized the MLF for unfavorable pricing. According to the group’s analysis, before the reduction in pricing, 97% of eligible cities, counties, and states could find better funding on the market. A letter signed by 53 progressive members of congress similarly criticized the facility for being “functionally unusable.”  In the Third Report of the Congressional Oversight Committee, the Chair of the Fed Jay Powell and Treasury Secretary Steven Mnuchin responded to such criticism by emphasizing that they had intended the MLF to be only a backstop for municipalities that had trouble getting funded on the municipal market. They also cited a Federal Reserve study showing that the market for municipal securities has recovered since March. 

The new pricing for tax-exempt notes is summarized in the table below. Interest rates are calculated by adding the comparable maturity overnight indexed swap (OIS) rate to the spread in the table below, based on the debt issuer’s credit rating. For most high-rated eligible issuers, the new pricing remains uncompetitive with market rates, so utilization of the facility will likely remain low. New York’s Metropolitan Transportation Authority said it may tap the Fed for half a billion in three-year notes, if pricing beats Wall Street.

Table 1. MLF Spread Table

Credit rating

Spread (bps): 

AAA/Aaa

100

AA+/Aa1

120

AA/Aa2

125

AA-/Aa3

140

A+/A1

190

A/A2

200

A-/A3

215

BBB+/Baa1

275

BBB/Baa2

290

BBB-/Baa3

330

Below Investment Grade

540

Source

The other change the Fed announced is a minor revision to the rates for taxable eligible notes. Previously, if notes were subject to federal income tax, pricing would be calculated by adding the comparable maturity OIS rate to the spread and dividing by 0.65; now the sum will be divided by 0.7. This improves the interest rate for taxable eligible notes.

This announcement comes as direct aid to state and local governments  is unlikely to pass Congress until September. Negotiations over the next round of fiscal spending have frozen in the Senate, while the White House has stepped in with four executive orders aimed at continuing expanded unemployment benefits and decreasing payroll taxes. The executive orders did not include funding for state and local governments, who a think tank estimates will face budget shortfalls of $555 billion over the next two years. 

The Fed says that the pricing will “provide an effective backstop to assist U.S. states and local governments as they weather the pandemic.”

US Municipalities