Bill Making Munis HQLA Passed

On May 24, 2018, President Donald J. Trump signed into effect the bill S. 2155, also known as the Economic Growth, Regulatory Relief and Consumer Protection Act. The bill rolls back reforms from the 2010 Dodd-Frank Act which hopes to bring regulatory relief to community banks across the U.S.

Let us go over the key tenets of the Act and learn how it might impact the different stakeholders.

Learn more about municipal bonds in our education section here.

The Act

The Act is divided into six distinct segments.

• Title I: improve consumer access to mortgage credit

• Title II: provide regulatory relief and protect consumer access to credit

• Title III: protect the credit information of consumers, including veterans and service members

• Title IV: tailor regulations for certain Bank Holding Companies, including raising the threshold levels for exemption from certain prudential standards and stress testing

• Title V: encourage capital formation by reforming certain Securities and Exchange Commission (SEC) regulations

• Title VI: protect student borrowers

One of the main provisions is in Section 403, which would reclassify investment-grade municipal bonds as a High-Quality Liquid Asset (HQLA). Large banks with assets of over $250 billion are required to meet a Liquidity Coverage Ratio (LCR) to ensure each bank has enough liquid assets in the event of financial stress.

As part of this liquidity measure, banks are required to have a certain amount in three levels of assets. Level 1 assets are Federal Reserve bank balances and foreign resources that can be withdrawn quickly, securities issued or guaranteed by specific sovereign entities and U.S. government–issued or guaranteed securities like Treasuries. Level 2A assets include securities issued by specific multilateral development banks or sovereign entities and securities issued by U.S. government-sponsored enterprises. Level 2B assets include publicly traded common stock and investment-grade corporate debt securities issued by non-financial sector corporations.

With the new bill passing, investment-grade municipal bond debt has been added to Level 2B assets, so banks will have an incentive to buy municipal bonds.

Banks Increasing Muni Exposure

Earlier this year, the banking industry was actually cutting its municipal bond exposure due to the Tax Cuts & Jobs Act. With corporate tax rates being cut to 21% from 35%, many banks no longer saw the need to have a large amount of tax-exempt bonds. As such, Bank of America Corp., Citigroup Inc., JPMorgan Chase & Co. and Wells Fargo & Co. together reduced their muni bond exposure by $7.8 billion during the first quarter of 2018, according to quarterly filings with the Securities and Exchange Commission.

However, this may have been premature with the new bill being passed; municipal bonds are now attractive for an entirely different reason. These banks, which are all over the $250 billion asset threshold, are likely to increase their stakes in municipal bonds again.

Impact on Muni Debt Issuers

The largest beneficiary for the new ruling is undoubtedly the bond issuers, especially those in state and local governments. With municipal bonds now a part of HQLA Level 2B, banks will be looking to add to their existing balance sheets. Municipal bonds are generally the primary financing tool that helps local government when making infrastructure improvements or construction updates. Many municipal bonds are issued to help fund local governmental projects like water and sewer, bridges, highways, airports and even power facilities.

With the demand for municipal bonds increasing overnight, these local governments can issue their bonds at a much lower rate than before. Overall, this helps the country’s total infrastructure plan, which was one of the main issues that President Trump was looking to improve upon.

Impact on Muni Debt Investors

Like any market, when demand is higher than supply, prices go up. With banks now looking to increase their exposure to municipal bonds, demand will be going up, which should increase bond prices. However, since only investment-grade bonds can be considered HQLA, investors should factor this in.

With the bond market already fairly thin to begin with, investors looking to reallocate to investment-grade municipal bonds should do it sooner, rather than later. For investors that already own investment-grade municipal bonds or mutual bond funds, expect the bond prices to increase.

Use our Municipal Bonds Screener to find municipal bonds for your specific investment needs.

The Bottom Line

Overall, the ruling has a positive effect on the financial industry. Critics are concerned because now the average investor will have to compete with the buying power of a large bank in an already thin market. However, this is a temporary issue as the ruling should incentivize local governments to issue more municipal bonds. This will also trickle down into helping improve the infrastructure of the country as a whole.

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