NEW YORK--(BUSINESS WIRE)--The introduction of Basel III liquidity coverage ratios (LCR) is, over time, expected to increase the cost and/or reduce the availability of bank liquidity support to certain short-term commitments, resulting in issuers looking at alternative commercial paper solutions, according to a Fitch Ratings report published today.
The recent Basel III LCR revisions introduced three major changes: an extended implementation schedule, expansion of eligible 'high quality liquid assets,' and reductions to run-off assumptions for certain contingent funding liabilities. Under LCR, banks would be required to hold highly liquid qualifying assets against such commitments.
Issuance of variable rate demand obligations (VRDO) and commercial paper by municipal issues reliant on letters of credit (LOCs) is expected to be adversely affected by higher costs and/or reduced access to LOCs.
The issuance of callable commercial paper is one solution municipal issuers have already used to reduce exposure to LCR-driven costs of liquidity back-up. A Fitch review of MMF portfolios in 2012 revealed that tax-exempt MMFs are important investors in callable securities.
Due to their novelty, callable securities may yield more than traditional VRDOs and commercial paper. Fitch notes there are some potential transparency challenges related to how MMFs report holdings of callable securities.
To date, Fitch has not observed any meaningful increase in the cost of borrowing or reduced LOC access for short-term issuers due to the impending effect of LCR. Fitch attributes the limited effects to the protracted implementation timeline and uncertainty with respect to the applicable run-off rate used in the LCR denominator or assumed run on bank liquidity. Nonetheless, Fitch expects that borrowers will pursue alternatives to existing short-term funding vehicles that rely on LOCs, as the regulatory changes are adopted.
Despite the extended implementation schedule, Fitch notes that banks have been preparing early for LCR compliance among the other requirements of Basel III.
The full report 'Callable CP: Short-Term Market Primer' is available at 'www.fitchratings.com.' This report is one of a series that Fitch will publish
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research Callable CP: Short-Term Credit Market Primer (Basel III Drives Innovation for Commercial Paper)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=705395
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