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Seix Muni Perspectives- HQLA & Munis (August 2017)

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Written by Ronald Schwartz, CFA and Scott Andreson
Written by Ronald Schwartz, CFA and Scott Andreson

Written by Ronald Schwartz, CFA and Scott Andreson, Director, Municipal Research

So far this year we have written several reports on federal policies that could impact the tax exempt asset class and public finance issuers. The reports have discussed tax reform, domestic infrastructure, ACA reform, Medicaid spending, federal fiscal stimulus, and sanctuary cities. This month, we will focus on another federal policy that could impact the municipal asset class, HQLA designation.

There are currently two bills moving through Congress that would designate certain municipal bonds as high quality liquid assets, or HQLA, for bank compliance liquidity coverage ratios (LCR). Regulators began requiring banks to hold enough liquid assets after the 2008 financial crisis in order to weather a short-term liquidity crunch. The LCR is used to measure HQLA held against liquidity needs over a 30-day liquidity stress period. The HQLA designation is made up of assets divided into three categories, Level 1, Level 2A, and Level 2B. 

  • Level 1assets are the most liquid with little credit risk and have no amount restrictions that
    can be held. Examples include cash, central bank reserves, and securities issued or guaranteed by
    sovereigns and central banks.
  • Level 2A assets are not as liquid as Level 1, but are still considered to be readily marketable,
    but may make up no more than 40% of total HQLA. Examples include guarantees by U.S. government-
    sponsored enterprises, other sovereign or multilateral development bank securities and conventional
    MBS.
  • Level 2B assets are not as liquid as Level 1, but are still considered to be readily marketable,
    but may make up no more than 15% of total HQLA. Examples include publicly traded corporate debt and
    some corporate equity shares.

Bank regulators did not include municipal bonds as HQLA under the original regulation because they felt the securities were not liquid enough. Municipal market participants were successful in getting the Federal Reserve Board in April 2016 to count liquid investment grade general obligation municipal bonds that meet the same criteria that currently applies to corporate debt securities, as Level 2B HQLA assets. However, the other two major financial regulating agencies, FDIC and Office of the Comptroller of the Currency (OCC) have not included munis as HQLA. Nonetheless, the current bills have solid bi-partisan support in the House and Senate and would apply to the Fed, FDIC, and OCC. The House bill would treat munis as Level 2A, while the Senate’s proposed bill would have munis at Level 2B. The Treasury Department, in response to President Trump’s executive order for regulating the U.S. financial system, has recommended that high-grade municipal securities be included as HQLA Level 2B under federal banking rules. READ MORE

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