The Effect of the COVID-19 Virus on Municipal Financial Markets and Potential County Assistance to Its Municipalities and School Boards
Gibbons Special Alert
March 31, 2020
Prior to the spread of the COVID-19 virus in the United States, municipal interest rates, both short-term and long-term, were at or near historical lows. The impact of the COVID-19 virus has disrupted the global economy, including the United States, and has rattled the financial markets, including the municipal marketplace, which has seen more disruption and dislocation than the other financial markets. Short-term tax-exempt municipal note interest rates (1 year) have risen from a range of approximately 1.00% – 1.30% to 2.50% – 3.50%. Certain New Jersey municipalities failed to receive bids on their notes. Long-term municipal bond interest rates have risen 100 to 200 basis points throughout the yield curve. There has also been a widening of the interest rate spreads between Aaa, Aa, and A rated governmental issuers.
Due to the spread of the coronavirus, Governor Murphy signed Executive Order 107, which ordered, among other things, the closure of all non-essential retail businesses. The effect of that order has caused a major reduction in economic activity in the state of New Jersey. This is beginning to cause a substantial revenue decline in municipal budgets, as municipalities are collecting lesser fees of various types and may experience potential reductions or delays in property tax receipts. Municipalities’ need to use tax anticipation notes to address cash flow issues has risen significantly. Furthermore, municipalities will be required to refinance their existing one-year notes or raise capital for various essential governmental projects, and they need an economical pathway to do so.
To that end and as detailed below, Gibbons has outlined a legal structure to enable municipalities and school boards to access the financial markets to address their various needs. This legal structure is now being considered by various counties and entails utilizing the powers of county improvement authorities to aid municipalities and school boards in their respective jurisdictions.
Improvement Authorities have the ability to issue notes for one year (the “Improvement Authority Notes”) and use the proceeds to purchase a municipality’s notes or school board’s notes. The Improvement Authority Notes would be secured by a guaranty from their county (a number of counties in New Jersey are Aaa/AAA rated by Moody’s and Standard & Poor’s, respectively). The county guaranty amount would be included in the county’s gross debt, but a deduction in the same amount would be taken on its debt statement. The county guaranty would be secured by each municipality’s or school board’s note, which is secured by the ad valorem taxing power of each municipality or school board.
The benefits of this program would be significant during the current municipal marketplace crisis. First, the county credit would provide market access to those municipalities and school boards that are having difficulty selling their notes due to credit concerns or due to the potentially small size of the notes. Second, the Improvement Authority Note would draw more interest from potential buyers due to its size (an aggregation of the municipal and school board notes). Third, the Improvement Authority Notes would obtain a rating from one of the rating agencies (unlike most municipalities and school boards if they went out on their own to sell their notes, which do not typically have a rating), which would likely attract additional investors. Lastly, and most importantly, the credit strength of the county would lower the interest costs for each municipality and school board.
As a supplemental tool, the counties may consider under the Pooled Loan Program purchasing notes of municipalities (bond anticipation notes and tax anticipation notes) and schools on a short-term basis (the note maturing within ninety days) if they need cash quickly, which municipal/school note would be refinanced by the Pooled Loan Program note issuance. This option will depend on cash availability at the county and the level of liquidity necessary to continue to run county operations.
The Gibbons Public Finance Team continues to work on providing creative and cost effective solutions to its governmental clients during these extraordinary times in the municipal marketplace. For more information, please contact John Draikiwicz.
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