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Municipal Bonds

U.S. government takes action to support municipal bonds

Cadmus M. Hicks
Director of Performance Risk and Analysis
The Capitol building

On 27 March, President Trump signed Coronavirus Aid, Relief, and Economic Security Act (or CARES Act, H.R. 748). A provision that may have the greatest impact on municipal issuers, added at the last minute, authorizes the U.S. Treasury to pay $150 billion to state, local, tribal and territorial governments.

Who qualifies for the grants?

To qualify for the grants, the government must certify that the money will be used to cover costs that:

 

Of the $150 billion allocated, $3 billion has been dedicated to the District of Columbia, Puerto Rico and other U.S. Territories, and $8 billion to tribal governments. The remaining $139 billion will be allocated to the states in proportion to population. The bill also provides $100 billion for hospitals and $10 billion for airports.

SPVs can now purchase municipal bonds

The legislation retains language from earlier versions that would allow the Federal Reserve (Fed) to establish special purpose vehicles (SPVs) that could purchase municipal securities, as well as corporate debt. The bill authorizes $454 billion to be used by the Treasury to make loans or loan guarantees or investments in “programs or facilities established by the Board of Governors of the Fed System for the purpose of providing liquidity to the financial system that supports lending to eligible businesses, states, or municipalities by:

 

Such vehicles would probably be structured like the recently established Primary Market Corporate Credit Facility (PMCCF), and the Secondary Market Corporate Credit Facility (SMCCF). The U.S. Treasury will take an equity position in those facilities to provide them with capital, and the Fed will deposit funds to support lending by the facilities. Prior to the enactment of the bill, the Treasury had about $30 billion in its Exchange Stabilization Fund that can be used for this purpose. The Fed anticipated leveraging that Treasury capital to offer $300 billion in new financing to corporations. The new capital made available through the CARES Act may be leveraged to a similar degree. 

Under terms laid out by the Fed, corporations must be of investment grade quality in order to utilize the facilities. Under the PMCCF, companies will receive loans or issue new bonds that mature in no more than four years. The SMCCF can purchase corporate bonds in the secondary market, and can also buy shares of exchange-traded funds that hold investment grade corporate debt.

The new legislation would require companies that receive direct loans from a Fed SPV to agree not to buy back stock or pay dividends until 12 months after paying off the loan, and to comply with certain limits on compensation. All lending from a Fed SPV would have to meet the Fed’s requirements as to credit quality under Federal Reserve Act Section 13(3), which allows the Fed to provide special financing under “unusual and exigent circumstances.”

Some industries face additional requirements

In addition to the $454 billion to support corporate and municipal debt markets via the Fed, the bill authorizes the Treasury to make loans directly to passenger air carriers ($25 billion), cargo air carriers ($4 billion) and businesses essential to national security ($17 billion).

Those recipients would face more onerous requirements. In addition to not buying back stock or paying dividends, the companies would have to maintain employment levels, and loans could not have a maturity of more than five years, and would bear an interest rate commensurate with the risks. To qualify, the companies must be unable to secure financing elsewhere, and must be expected to incur losses that jeopardize their continued operation. Finally, the Treasury Department is authorized to acquire an equity interest in the companies in order to participate in any later appreciation in value.

What about short-term debt?

While the new bill would thus allow the Fed to support the long end of the municipal market through SPVs, the Fed has already announced programs to support short-term municipal debt. On 20 Mar 2020, the Fed announced the creation of a Money Market Mutual Fund Liquidity Facility and specified the terms for collateral that it would require to make loans to banks to allow them to purchase assets from municipal money market funds. The requirements for municipal debt were that it:

 

At that time, the Fed said it will not take variable rate demand notes (VRDNs) or tender option bonds, but on 23 March it said that it would accept VRDNs (however with no mention of tender option bonds).

Previous legislation covers state and local governments

In addition to the massive spending bill passed by Congress on 27 March, Congress and the Executive Branch took steps earlier in March to aid state and local governments. H.R. 6074 provides $950 million to state and local health departments. President Trump declared a Stafford Act national emergency, which allows the Disaster Relief Fund to reimburse 75% of the costs associated with the virus. Finally, H.R. 6201 increased by 6.2 percentage points the Federal Medicaid Assistance percentage, which is the federal Government’s share of Medicaid costs.

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Endnotes

Sources

Coronavirus Aid, Relief, and Economic Security Act, H.R. 748

https://www.appropriations.senate.gov/imo/media/doc/FINAL%20FINAL%20CARES%20ACT.pdf

Federal Reserve announcements

https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20200320b1.pdf

https://www.federalreserve.gov/newsevents/pressreleases/monetary20200323b.htm Federal Reserve Act Section 13

https://www.federalreserve.gov/aboutthefed/section13.htm

The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

A word on risk

Investing involves risk; principal loss is possible. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Investing in municipal bonds involves risks such as interest rate risk, credit risk and market risk. The value of the portfolio will fluctuate based on the value of the underlying securities. There are special risks associated with investments in high yield bonds, hedging activities and the potential use of leverage. Portfolios that include lower rated municipal bonds, commonly referred to as “high yield” or “junk” bonds, which are considered to be speculative, the credit and investment risk is heightened for the portfolio. Bond insurance guarantees only the payment of principal and interest on the bond when due, and not the value of the bonds themselves, which will fluctuate with the bond market and the financial success of the issuer and the insurer. No representation is made as to an insurer’s ability to meet their commitments. This information should not replace an investor’s consultation with a professional advisor regarding their tax situation. Nuveen Asset Management is not a tax advisor. Investors should contact a tax advisor regarding the suitability of tax-exempt investments in their portfolio. If sold prior to maturity, municipal securities are subject to gain/losses based on the level of interest rates, market conditions and the credit quality of the issuer. Income may be subject to the alternative minimum tax (AMT) and/or state and local taxes, based on the state of residence. Income from municipal bonds held by a portfolio could be declared taxable because of unfavorable changes in tax laws, adverse interpretations by the Internal Revenue Service or state tax authorities, or noncompliant conduct of a bond issuer. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.

CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute.

Nuveen Asset Management, LLC is a registered investment adviser and an affiliate of Nuveen, LLC. Nuveen provides investment advisory solutions through its investment specialists.

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