![]() Lower volume should offset possible price declines In a normal functioning market, any such paring activity should be absorbed by other investors given the current out of balance dynamic between supply and demand without driving prices down significantly. Everything else being equal, less demand will cause prices to fall, and yields to increase. Longer term, we do expect certain, affected banks to pare holdings as time passes. While bank participation in the market is significant and important, we do not foresee a rash of selling by affected banks in the near term. The after-tax yield advantage produced by current municipal bond returns versus comparable high-quality taxable securities (given a near zero cost of deposits) for these banks will be difficult to let go. We believe that profitable banks subject to Basel III should also continue to hold significant positions in municipal securities, especially if loan demand remains tepid. As long as these institutions remain profitable, they will continue to hold most of their current positions. Strong bank profitability and weak loan demand were important contributing factors to this increase in bank holdings.Ī good portion of this $425 billion is held by commercial banks not subject to the proposed rule. $425 billion represents approximately 10%-12% of the total municipal market. This has helped to keep prices up and yields low. Bank demand has been very strong over the last 4-5 years, increasing municipal holdings 60-70%. commercial banks hold approximately $425 billion worth of municipal securities. Rash of selling by affected banks unlikely Here are some additional facts and my thoughts on the issue as it has developed over the past 7-8 months. I sit on the municipal bond technical committee of BDA and have contributed a bit to this effort. The proposed rule seeks to include qualifying assets that can be liquidated quickly in large amounts with little impact on prices.īond Dealers of America has been an active participant in the ongoing discussion with regulators and elected officials since the rule was proposed. Level 2 assets are limited to 40% of coverage requirement and Level 2B assets cannot exceed 15% of the total. Investment grade corporate debt having certain characteristics and equities in the Standard and Poor’s 500 Index. Securities issued by U.S, government sponsored enterprises and specific other sovereign entities (Fannie Mae, Freddie Mac, as examples). These assets are not subject to a haircut. Regulators proposed three classes of HQLA: The proposed rule excluded municipal bonds from qualifying as a HQLA, which would be a negative demand factor for the market. Proposed HQLA excludes municipal bondsĮarlier this year the Federal Reserve Bank, OCC and FDIC proposed new liquidity requirements consistent with the Basel III liquidity coverage standard. As you may know, the rule has not yet been finalized and the situation remains fluid (an August 28th letter from Bond Dealers of America, or BDA, on the situation follows). We have been adjusting our portfolio management strategy somewhat in trying to anticipate a market change and reaction to an implemented, final rule. ![]() For many months, we at Bernardi Securities have closely followed the issue of municipal securities and their status as a high-quality liquid asset (HQLA) for commercial banks and nonbank systemically important financial institutions, or SIFIs (those with total assets exceeding $250 billion).
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