‘Where No Fed Has Gone’: Wall Street Reacts to Muni-Debt Program

(Bloomberg) -- The Federal Reserve on Thursday said it will lend as much as $500 billion to states and the biggest counties and cities, making its first direct move ever into the $3.9 trillion municipal-debt market to help limit the financial fallout of the coronavirus pandemic.

The step will help governments cover the shortfalls they are facing because of the vast shutdowns sweeping over much of the country and prevent waves of short-term borrowing by localities sold to plug budget holes from potentially destabilizing the public markets.

The move was broadly welcomed by Wall Street analysts, municipal bond investors, underwriters and lobbying groups, even though it fell short of buying already-issued debt as some had sought. Moreover, it’s only open to cities with a population above 1 million and counties with 2 million or more, limiting its direct effect on local governments to the 26 that are big enough to qualify, based on Census figures.

Bank Analysts’ Views

Municipal strategists at Barclays Plc said that the program is a “positive development” because it will relieve pressure on the new-issue market, though it “probably falls well short of investor expectations.” The group led by Mikhail Foux, predicts eligible governments will tap the program “aggressively,” with the tax revenue of states and local municipalities expected to drop by $350 billion or more.Bank of America analysts Yingchen Li and Ian Rogow said the move is “broadly positive for muni market” since it should lower interest rates and improve investors’ confidence, likely resulting in lower risk premiums. The group estimates the Fed could purchase as much as $268.2 billion of notes directly from the 50 states and Washington D.C., based on the limits included in the program.Jeffrey Lipton, head of municipal research at Oppenheimer & Co., said “the Fed is going where no Fed has gone before” and he expects that it will be followed by other operations directed at the municipal-securities market. Lipton said further thought has to be given to the efficacy of what he called a “short-term fix” and is skeptical of the long-term impact on credit.Eric Kazatsky, municipal strategist for Bloomberg Intelligence, said the Fed’s entry on the short end of the market could cloud the pricing of risk for borrowers like Illinois, which is on the cusp of junk. “While the Fed’s deeper involvement is welcome news to those in municipal finance, potential for disruption in credit spreads in the front end of the curve is a real possibility.”

Buyers Weigh In

The Fed’s decision is positive and will provide state and local government with liquidity to get through what is a very difficult time, said Matthew Norton, co-head of municipal portfolio management at AllianceBernstein. “I think the Fed will do whatever it takes,” he said. If the market needs more liquidity they certainly would step up and do so as they have in other asset classes.”Jim Evans, the chief investment officer for fixed-income at Parametric Portfolio Associates, said that the Fed is looking for states to make decisions for smaller entities in order to fully vet their needs. That vetting “encourages issuers that can access markets to do that in the normal market channels and not use this facility,” he said.Still, some investors said that more action may be needed. RJ Gallo, senior portfolio manager at Federated Hermes, said he was disappointed that the Fed wouldn’t buy municipals in the secondary market like it’s doing with corporate bonds. “Perhaps that may evolve in the future if this program fails to provide sufficient capital and liquidity support,” he said.Thomas Graff, a portfolio manager at Brown Advisory, said the lending program won’t help cash-strapped not-for-profit hospitals and nursing homes that are reeling from the impact of the virus. He said a more broad purchasing program could help those credits. “Ultimately that would help a wider range of issuers, including non-profit hospitals and nursing homes.”

Lobbyists Want More

Lobbying groups for state and local governments had pressed the Fed to wade into the market in light of the sell-off last month. Mike Nicholas, CEO of the Bond Dealers of America, said the group representing banks and dealers welcomed the new program but wants the Fed to provide support as needed to the secondary market. “We are looking particularly at how smaller issuers will access the facility,” Nicholas said in a statement.The American Securities Association, a lobbying group that represents regional financial services firms, said the program “misses the mark” for smaller local governments. “These areas represent the heartbeat of America and for some reason the Fed and Treasury have chosen to exclude them while backstopping the largest cities, which doesn’t make any sense,” CEO Chris Iacovella said in a statement.

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