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U.S. States Beg, Borrow and Cut to Close Massive Budget Gaps

It’s crunch time for U.S. states as they face their worst fiscal crisis in decades brought on by the Covid-19 pandemic that’s decimated tax collections.

Eleven states have yet to enact a budget for the fiscal year that begins Wednesday. And for those that have, they’ve been forced to slash spending, lay off workers and count on billions of dollars in potential federal aid that remains bogged down in Washington.

“The biggest theme that we are seeing across state budgets is uncertainty,” said Eric Kim, senior director of public finance at Fitch Ratings.

The financial crisis amid the pandemic is forcing states and cities to make tough choices even as they seek help from Washington. Moody’s Analytics has projected that state and local governments will need at least $500 billion in additional federal aid over the next two years to avoid major economic damage. While House Democrats passed a stimulus measure that would provide some $1 trillion of aid to governments, the rescue has stalled in the Republican-led Senate.

Thirty-five states have enacted a full-year budget for fiscal 2021, including two — Virginia and Wyoming — that have authorized two-year budgets for both fiscal 2021 and fiscal 2022. Forty-six states operate on a fiscal year that begins July 1. New York starts its year on April 1, while Texas begins on Sept. 1, and Alabama and Michigan start on Oct. 1.

For those states that have yet to enact a full-year budget or temporary budget for fiscal 2021, some are awaiting their governors’ signature, while others are holding off for updated economic and revenue estimates.

“Even with states that have enacted full-year budgets, this will be a banner year for mid-year adjustments,” Kim said. “And that’s because the revenue picture is constantly falling, and that’s really going to be an unprecedented level of change for state budgets.”

New Jersey opted to extend its fiscal year through Sept. 30, with lawmakers approving a temporary $7.7 billion spending plan intended to buy the state more time to close the massive budget shortfall caused by business closings and record unemployment. It cuts or shifts $5 billion in expenses.

Related: N.J. Lawmakers Send $7.7 Billion Stopgap Spending Bill to Murphy

Vermont also expects to enact a three-month temporary budget, and Massachusetts signed a temporary one-month budget for July. Kentucky, which normally operates on a two-year budget, passed a one-year spending plan, citing pandemic uncertainties.

The budget that Illinois enacted earlier this month allows the state to borrow up to $5 billion from the Federal Reserve that could be repaid with anticipated federal aid. The state has already borrowed $1.2 billion from the Municipal Liquidity Facility program to help pay down bills. Illinois’s spending plan is “precariously balanced,” according to S&P Global Ratings.

California Governor Gavin Newsom Monday signed a $133.9 billion budget that defers almost $13 billion in payments and borrows another $9 billion internally to help fill a deficit expected to reach $54 billion over two years. The spending plan is intended to avoid steep cuts in the hope that Washington will send additional aid by October.

Most states aren’t depending on federal aid in their budgets, but they’re “strongly advocating for it,” Kim said.

“They are trying to position themselves that if they get the revenue,” he said. “then they have a sense of the kinds of cuts they can roll back.”

Related: California ‘Wall of Debt’ Returns as State Bets on Federal Aid

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Fed Is All In: Here Are the Key Features of Its Lending Programs

The Federal Reserve has announced a raft of emergency lending programs, with approval from the Treasury Department, to help the U.S. economy weather the devastating impact of the coronavirus pandemic. These could ultimately deploy trillions of dollars in lending.

The programs seek to keep financial markets functioning and, in unprecedented steps, provide direct loans to businesses, states and local governments.

Here’s a round-up of the nine programs — all of which are now up and running — with details on their current status. Lending totals are as of June 24, with the exception of the corporate credit and municipal facilities which reflect totals as of June 23. Holdings will be updated every Thursday:

Commercial Paper Funding Facility (CPFF)

  • Announced: March 17
  • Launched: April 14
  • Treasury backstop: $10 billion
  • Program limit: none
  • Deployed: $4.3 billion (excluding $8.5 billion from backstop)

Purchases short-term company IOUs directly from U.S. corporate and municipal issuers. Eligible securities about $1.1 trillion. Demand has been low as the Fed’s mere pledge to backstop the market drew normal lenders back in.

Primary Dealer Credit Facility (PDCF)

  • Announced: March 17
  • Launched: March 20
  • Treasury backstop: none
  • Program limit: none
  • Deployed: $3.6 billion

Buys a wide range of securities — with an agreement to sell back at a future date — including investment-grade corporate debt, municipal debt, and mortgage- and asset-backed securities from primary dealers, which are the big banks and broker-dealers licensed to transact with the Fed. Its lending peaked in mid-April at around $33 billion, then faded as the short-term funding markets calmed.

Money Market Fund Liquidity Facility (MMFLF)

  • Announced: March 18
  • Launched: March 23
  • Treasury backstop: $10 billion
  • Program limit: none
  • Deployed: $22.9 billion

Finances the purchase of high-quality assets from U.S. money market mutual funds, including government debt, commercial paper and municipal debt. Eligible securities estimated at $600 billion to $700 billion, according to Fed officials. Lending peaked in early April at around $53 billion as withdrawals from prime money funds halted and then reversed.

Primary Market Corporate Credit Facility (PMCCF)

  • Announced: March 23
  • Launched: June 29
  • Treasury backstop: $50 billion
  • Program limit: $500 billion
  • Deployed: $0

Will buy investment-grade corporate debt with maturities of up to four years directly from U.S. issuers, and debt from some issuers downgraded after March 22.

Secondary Market Corporate Credit Facility (SMCCF)

  • Announced: March 23
  • Launched: May 12
  • Treasury backstop: $25 billion
  • Program limit: $250 billion
  • Deployed: $8.7 billion (excluding $31.9 billion from backstop)

Purchase investment-grade corporate debt from U.S. issuers with maturities up to five years in the secondary market, debt from some issuers downgraded after March 22 and some ETFs that buy corporate debt. The New York Fed began ETF purchases on May 12 and eligible corporate bonds after June 15.

Term Asset-Backed Securities Loan Facility (TALF)

  • Announced: March 23
  • Launched: June 16
  • Treasury backstop: $10 billion
  • Program limit: $100 billion
  • Deployed: $0 (excluding $8.5 billion from backstop)

Will purchase securities backed by credits to consumers and small businesses, including credit-card receivables, student loans, auto loans and leases, equipment loans and some small business loans.

Paycheck Protection Program Liquidity Facility (PPPLF)

  • Announced: April 6
  • Launched: April 16
  • Treasury backstop: none
  • Program limit: none
  • Deployed: $62.6 billion

Finances lending to small businesses that qualify for the Treasury’s Paycheck Protection Program. Congress appropriated a total of $669 billion for the loans, which can turn into grants if companies retain or hire back workers.

Municipal Liquidity Facility (MLF)

  • Announced: April 9
  • Launched: June 2
  • Treasury backstop: $35 billion
  • Program limit: $500 billion
  • Deployed: $1.2 billion (excluding $14.9 billion from backstop)

Will purchase municipal debt maturing in less than 36 months directly from states, counties and cities. After initial criticism, the Fed lowered the population thresholds for eligible counties and cities to 500,000 and 250,000, respectively. Issuers must have held an investment-grade rating as of April 8.

Main Street Lending Program

  • Announced: April 9
  • Launched: June 15
  • Treasury backstop: $75 billion
  • Program limit: $600 billion
  • Deployed: $0 (excluding $37.5 billion from backstop)

Will finance full recourse bank lending to U.S. companies with fewer than 15,000 employees or less than $5 billion in annual revenue. The four-year loans will be extended through three distinct facilities: one for new loans, another for increasing existing debt and a third for more heavily leveraged borrowers.

  • New Loan Facility: Maximum loan size of $25 million or four times 2019 adjusted EBITDA. Lenders retain a 5% stake in each loan. Minimum loan size is $500,000.
  • Expanded Loan Facility: Maximum loan size $200 million, 35% of a borrower’s outstanding debt or six times 2019 adjusted EBITDA. Lenders retain a 5% stake. Minimum loan size is $10 million.
  • Priority Loan Facility: Maximum loan size of $25 million or six times 2019 adjusted EBITDA. Lenders retain 15% stake. Minimum loan size is $500,000.

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Faith in the Fed to Get Fresh Test as Markets Shudder at Virus

Investor faith in the largess of central banks is about to be tested anew as the soaring rate of Covid-19 infections re-establishes itself as the chief obsession of markets.

Confirmed coronavirus cases surpassed 10 million at the weekend, continuing an accelerating trend that’s decimating economies around the world. The S&P 500 Index dropped 2.4% on Friday as the rising numbers prompted some American states to curtail reopening plans. The yield on the benchmark 10-year Treasury note slipped to the lowest level since May 14 and the Bloomberg Dollar Index rounded off a third week of gains as investors sought havens.

The renewed risk-off tone is likely to dominate when trading starts in Asia on Monday, according to analysts, though a report Sunday showing the first increase in profits at Chinese industrial enterprises since November may provide some support to stocks.

“Investors’ recent love of U.S. risky assets will soon reverse as the U.S. will battle the resurging pandemic,” Erik Nielsen, the London-based chief economist at UniCredit SpA, wrote in a note Sunday. “Stating the obvious: don’t fight the major central banks. They’ll remain in the game for years to come.”

42,597 in U.S.Most new cases today

-10% Change in MSCI World Index of global stocks since Wuhan lockdown, Jan. 23

-1.​091 Change in U.S. treasury bond yield since Wuhan lockdown, Jan. 23

-2.​3% Global GDP Tracker (annualized), May

Israel’s TA-35 index led declines in Middle East markets Sunday, sliding as much as 2.9%. Stocks in Bahrain, Qatar, Jordan and Egypt also retreated.

The following is a round-up of comments looking ahead to a week in markets:

Erik Nielsen, chief economist at UniCredit in London:

  • “Markets have been struggling to see through the fog these past months, but greater clarity is now emerging and that leaves a picture of several mispriced asset classes. I expect many of these will be somewhat corrected during the second half of the year.
  • There will be “some moderation of recent months’ ultimate safe-haven status for the dollar; i.e. a prospect of a gradually weaker dollar.
  • “I also worry about emerging market assets. Emerging-market equities have held up relatively well, but this does not square with the dreadful numbers now emerging for their infection and death rates from the pandemic in a deglobalizing world that will struggle to get back to potential, hence limiting the upside for commodities.
  • “With a more convincing growth trajectory, big positive policy reforms under way and some seriously under-valued asset classes, Europe is likely to be a key recipient of the allocation away from the U.S. and EM.

Bank of America Securities analysts Ioannis Angelakis, Barnaby Martin and Elyas Galou:

  • “The central bank-driven euphoria seems to be in consolidation mode” as inflows into high-grade and government bonds slow amid the risk of a second wave.
  • “Only two weeks ago, investors across Europe were adding risk at an unprecedented rate. However, the last two weeks saw a marked slowdown of inflows across credit and the EM debt space.”

Iyad Abu Hweij, the managing partner at Allied Investment Partners PJSC in Dubai:

  • “Global equities performed negatively during the week as investors were concerned about resurgence in Covid-19 cases. The rise in new cases could possibly lead to another lockdown in certain parts of the U.S. and around the world, which will delay the recovery process.”
  • “Going forward, investors will reassess their portfolios to reduce the overall risk amid the rising uncertainties post the resurgence in Covid-19 cases.
  • “Moreover, equity markets might witness increased volatility in the coming weeks as odds of downside risk are rising post the sharp rebound in equities since mid-March.”

Nader Naeimi, head of dynamic markets at AMP Capital in Sydney:

  • “While emerging market equities have posted strong gains from their late March lows, they have continued to underperform developed-world equities.
  • “With inventory levels at historical lows, business expectations rebounding and new orders picking up, 2H 2020 is likely to be the start of a multi-month upswing in the manufacturing cycle. This will provide a significant tailwind for EM markets.
  • “The combination of a falling U.S. dollar together with ultra-easy monetary policy will super charge EM equities relative performance in the second half.
  • “I am expecting a much stronger absolute and relative performance by EM from here” for currencies and stocks.

Jens Nystedt, a New York-based senior portfolio manager at Emso Asset Management:

  • “We see the best opportunities in emerging-market fixed-income assets that have recovered the least so far and have not yet priced in a reset higher in global economic activity. There are still EM oil exporters that faced a dual shock of the Covid-19 crisis combined with an oil price war that are still screening cheap. In addition, better global growth, likely led by non-U.S. large economies, would be a headwind to the dollar and allow beaten up EM currencies to also stabilize and eventually recover.
  • “Emerging-market debt, by and large, can sustain the rebound given the unprecedented fiscal and monetary policy actions by the major economies, barring a second wave larger than the first one for Covid-19. Given the unprecedented backstop for high-grade and high-yield fixed-income markets in the U.S. and Eurozone, investors looking for yield remain interested in picking winners versus losers. Large real interest-rate differentials will allow EM to attract portfolio inflows among the better quality names.
  • “At the end of this crisis, debt burdens will weigh on the growth potential for many economies and the recovery in growth risks taking longer than what the market current anticipates. It is hard for the market to differentiate between a V-shaped reset in growth and a follow on very sluggish recovery.”

— With assistance by Filipe Pacheco, and Netty Idayu Ismail

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