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Law360 (April 9, 2020, 5:22 PM EDT )
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| Lee Meyerson |
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| Keith Noreika |
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| Adam Cohen |
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| Spencer Sloan |
The MMLF, which opened on March 23, will assist eligible money market funds in meeting demands for redemptions by households and other investors, enhancing overall market functioning and credit provision to the broader economy.
Background of the MMLF
After announcing the establishment of the MMLF for purposes of making loans available to eligible financial institutions secured by high-quality assets purchased by the financial institutions from prime money market mutual funds, the Federal Reserve announced on March 20 that it would expand the MMLF program to allow loans secured by high-quality assets purchased from money market funds that invest in securities issued by a single U.S. state and other tax-exempt municipal money market funds, as well as to permit a broader range of eligible collateral under the facility.
Further, as discussed below, the Federal Reserve again expanded the MMLF on March 23 to include a wider range of securities, including municipal variable rate demand notes, or VRDNs, and bank certificates of deposit purchased from eligible money market mutual funds, that would be eligible as collateral. The program does not have an aggregate limit on funding.
The MMLF was established pursuant to Section 13(3) of the Federal Reserve Act, which provides the Federal Reserve with emergency lending authority to companies other than depository institutions through broad-based programs and facilities that relieve liquidity pressures in financial markets.
The U.S. Department of the Treasury will provide $10 billion of credit protection to the Federal Reserve in connection with the MMLF from the Treasury's Exchange Stabilization Fund. The MMLF program is structured similarly to the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility that the Federal Reserve operated during the 2008 global financial crisis, except that a broader range of assets will be eligible for purchase under the MMLF.
The MMLF is part of a series of recent actions by the Federal Reserve Board to support the U.S. economy, including lowering interest rates and bank reserve requirements, encouraging discount window borrowing, enhancing the provision of liquidity via the standing U.S. dollar liquidity swap line arrangements with other major central banks, as well as the recent establishment of a commercial paper credit facility, a primary dealer credit facility, primary and secondary market corporate credit facilities and a term asset-backed securities loan facility.
MMLF Terms and Conditions
Under the MMLF, the Federal Reserve Bank of Boston will provide a nonrecourse advance to eligible borrowers, taking as collateral certain types of high-quality assets purchased by the financial institution from certain money market mutual funds. The following is a high-level summary of key terms and conditions for advances under the MMLF.
Eligible Borrowers
Eligible borrowers under the MMLF include all U.S. depository institutions, U.S. bank holding companies and their U.S. broker-dealer subsidiaries, and U.S. branches and agencies of foreign banks.
Eligible Funds
A money market mutual fund from which an eligible borrower purchases eligible collateral must identify itself as a prime, single-state or other tax-exempt money market fund under item A.10 of U.S. Securities and Exchange Commission Form N-MFP.
Advance Maturity
The maturity date of an advance will be the earlier of: (1) the maturity date of the eligible collateral pledged to secure the advance, and (2) 12 months from the date of the advance.
Advance Size
Each advance shall be in a principal amount equal to the value of the collateral pledged to secure the advance.
Eligible Collateral
Collateral that is eligible for pledge under the MMLF include the following:
- U.S. treasuries and fully guaranteed agency securities;
- Securities issued by U.S. government-sponsored entities;
- Asset-backed commercial paper, unsecured commercial paper or a negotiable certificate of deposit that is issued by a U.S. issuer and that has a short-term rating at the time purchased from the fund or pledged to the Federal Reserve Bank of Boston in the top rating category (e.g., not lower than A1, F1 or P1, as applicable) from at least two major nationally recognized statistical rating organization or, if rated by only one major NRSRO, is rated within the top rating category by that NRSRO;
- U.S. municipal short-term debt (excluding VRDNs) that (1) has a maturity that does not exceed 12 months; and (2) at the time purchased from the fund or pledged to the Federal Reserve Bank of Boston:
- Is rated in the top short-term rating category (e.g., rated SP1, MIG1, or F1, as applicable) by at least two major NRSROs or if rated by only one major NRSRO, is rated within the top rating category by that NRSRO; or
- If not rated in a short-term rating category, is rated in one of the top two long-term rating categories (e.g., AA or equivalent or above) by at least two major NRSROs or if rated by only one major NRSRO, is rated within the top two rating categories by that NRSRO.
- VRDN that: (1) has a demand feature that allows holders to tender the note at their option within 12 months; and (2) at the time purchased from the fund or pledged to the Federal Reserve Bank of Boston:
- Is rated in the top short-term rating category (e.g., rated SP1, VMIG1, or F1, as applicable) by at least two major NRSROs or if rated by only one major NRSRO, is rated within the top rating category by that NRSRO; or
- If not rated in a short-term rating category, is rated in one of the top two long-term rating categories (e.g., AA or equivalent or above) by at least two major NRSROs or if rated by only one major NRSRO, is rated within the top two rating categories by that NRSRO.
In addition, the MMLF may accept receivables from certain repurchase agreements. The feasibility of adding these and other asset classes to the facility will be considered by the Federal Reserve in the future.
Timing of Collateral Acquisition
The MMLF will generally take eligible collateral that:
- If purchased after March 23, is pledged concurrently with the borrowing; or
- If purchased on or after March 18 but on or before March 23 is pledged expeditiously starting on March 23.
For negotiable certificates of deposit and VRDNs, a borrower may purchase these assets on or after March 23 and pledge them on or after March 25.
Collateral Valuation
The collateral valuation will either be amortized cost or fair value. For asset-backed commercial paper, unsecured commercial paper, negotiable certificates of deposit, and U.S. municipal short-term debt, including VRDNs, the valuation will be amortized cost.
Rate
Advances made under the MMLF that are secured by U.S. treasuries and fully guaranteed agency securities or securities issued by U.S. government-sponsored entities will be made at a rate equal to the primary credit rate in effect at the Federal Reserve Bank of Boston that is offered to depository institutions at the time the advance is made.
Advances made under the MMLF that are secured by U.S. municipal short-term debt, including VRDNs, will be made at a rate equal to the primary credit rate in effect at the Federal Reserve Bank of Boston that is offered to depository institutions at the time the advance is made plus 25 basis points.
All other advances will be made at a rate equal to the primary credit rate in effect at the Federal Reserve Bank of Boston that is offered to depository institutions at the time the advance is made plus 100 basis points.
Fees
There are no special fees associated with the MMLF.
Credit Protection by Department of the Treasury
The Department of the Treasury, using the Exchange Stabilization Fund, will provide $10 billion as credit protection to the Federal Reserve Bank of Boston.
Nonrecourse
Advances made under the MMLF are made without recourse to the borrower, provided the requirements of the MMLF are met.
Program Termination
No new credit extensions will be made after Sept. 30, 2020, unless the MMLF is extended by the Federal Reserve Board. Terms of the program may be adjusted before that time as market conditions warrant.
Regulatory Capital Treatment of the MMLF
Separately and consistent with the purposes of the MMLF, the Federal Reserve Board, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corp. issued an interim final rule to neutralize the impact of a depository institution holding company or depository institution's participation in the MMLF for purposes of the agencies' regulatory capital requirements, including risk-based capital and leverage requirements (including the community bank leverage ratio).
Participation in the MMLF will affect the balance sheet of a banking organization because the banking organization must acquire and hold assets (that is, eligible collateral to be pledged to the Federal Reserve Bank of Boston) on its balance sheet. As a result, a banking organization that participates in the MMLF could potentially be subject to increased capital requirements.
The interim final rule permits banking organizations to exclude nonrecourse exposures acquired as part of the MMLF (including assets purchased beginning on March 19 and pledged to the Federal Reserve Bank of Boston in connection with this facility) from a banking organization's total leverage exposure, average total consolidated assets, advanced approaches-total risk-weighted assets, and standardized total risk-weighted assets, as applicable.
Perspective and Analysis
In the days prior to the initiation of the program, some money market mutual funds experienced significant demands for redemptions by investors. Under ordinary circumstances, such funds would meet investor redemption requests by drawing on cash reserves or by selling assets. Recently, however, many money markets had become illiquid due to uncertainty related to the coronavirus outbreak.
This illiquidity in the money markets raised the risk of money market mutual funds needing to sell assets at deep discounts to meet the redemption requests of investors who were leaving such funds for less risky investments. Selling assets at such discounts in turn increased the risk of substantial losses for the funds, likely resulting in further loss of investor confidence and even higher levels of future redemptions.
By providing nonrecourse loans to eligible borrowers to fund the purchase of eligible assets from money market mutual funds, the MMLF is designed to foster liquidity in the market for eligible money market mutual fund assets and money markets in general.
As noted above, the MMLF is similar in structure to the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, or AMLF, operated by the Federal Reserve during the 2008 financial crisis. After becoming operational in late September 2008, soon after the Reserve Primary Fund broke the buck, the AMLF's lending levels peaked almost immediately, with the AMLF reaching its maximum outstanding utilization of $152.1 billion on Oct. 1, 2008. Utilization tapered off as funding markets gradually stabilized and redemption pressures subsided.
While current utilization data is not yet known, it is possible that the MMLF will see a similar spike in early utilization before gradually tapering off. By quickly establishing the MMLF, however, including by expanding the scope of assets eligible for purchase under the facility, the Federal Reserve has taken early action aimed at stabilizing the money markets and avoiding further significant financing dislocation as a result of the COVID-19 pandemic.
Lee Meyerson is a partner at Simpson Thacher & Bartlett LLP and head of the firm's financial institutions practice.
Keith Noreika is a partner at the firm and a former acting comptroller of the currency.
Adam Cohen is counsel at the firm and former counsel at the Board of Governors of the Federal Reserve System.
Spencer Sloan is an associate at the firm.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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