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U.S. government takes action to support municipal bonds

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Early on Wednesday, 25 March, leaders in the U.S. Congress and the Executive Branch agreed on the terms of legislation to address the coronavirus crisis (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:
  • “Are necessary expenditures incurred due to the public health emergency with respect to the Coronavirus Disease 2019 (COVID-19).
  • Were not accounted for in the budget most recently approved as of the date of enactment of this section for the state or government.
  • Were incurred during the period that begins on 1 Mar 2020, and ends on 30 Dec 2020.”
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:
  • Purchasing obligations or other interests directly from issuers of such obligations or other interests.
  • Purchasing obligations or other interests in secondary markets or otherwise.
  • Making loans, including loans or other advances secured by collateral.”
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. Currently, the Treasury has about $30 billion in its Exchange Stabilization Fund that can be used for this purpose. The Fed anticipates leveraging the Treasury capital to offer $300 billion in new financing to corporations.

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:
  • Has a maturity that does not exceed 12 months.
  • At the time purchased from the Fund or pledged to the Reserve Bank:
    • If rated in the short-term rating category, is rated in the top short-term rating category (e.g., rated SP1, MIG1, or F1, as applicable) by at least two major rating agencies or if rated by only one major rating agency, is rated within the top rating category by that agency.
    • If not rated in the short-term rating category, is rated in the top long-term rating category (e.g., AA or above) by at least two major rating agencies or if rated by only one major rating agency, is rated within the top rating category by that agency.
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
 
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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.

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