With the election around the corner and divisive political discourse on full display, who would have thought that consensus could be reached anywhere, let alone over the municipal bond market? But it’s true. Bipartisan legislation that would allow large banks to use certain high-quality state general obligation bonds to meet Federal Reserve (Fed) and Basel Accord liquidity requirements is under review in Congress. H.R. 2209 was passed in the House of Representatives in February, and the Senate introduced its own version, S. 3404, on September 26, 2016. It’s too early to determine whether this will impact demand for municipals; however, it is worth monitoring as banks are large participants in the municipal bond market, as the chart below shows.
In the wake of the banking crisis in 2008, Basel regulations were developed that require banks with $250 billion or more in assets to maintain liquidity coverage ratios. These added rules were designed to make banks more resilient to financial stress. Prior to the introduction of H.R. 2209 in May of 2015, none of the major bank regulators, including the Fed, the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC), allowed municipal bonds to be accepted as high-quality liquid assets (HQLA). The Fed ruled on April 1, 2016 to allow certain U.S. state general obligation bonds to be used as HQLA, but the OCC and FDIC still have not. In late September, a bipartisan group of senators introduced legislation (S. 3404) that would allow banks to categorize some of their municipal bond positions as HQLA to meet liquidity standards. Although slightly different than the House bill, it could still be a way to give banks more consistency on the issue, and also could potentially be a net positive for municipal bonds.
Only time will tell if a bill passes, but the fact that both parties are working together on the legislation is refreshing in this highly sensitive political season. We will continue to watch this issue in light of its potential impact on the municipal bond market.
The economic forecasts set forth in the presentation may not develop as predicted.
The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise, and bonds are subject to availability and change in price.
Municipal bonds are subject to availability, price, and to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rate rise. Interest income may be subject to the alternative minimum tax. Federally tax-free but other state and local taxes may apply.
This research material has been prepared by LPL Financial LLC.
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