© The Financial Times Ltd 2016 FT and 'Financial Times' are trademarks of The Financial Times Ltd.
Last updated: January 29, 2013 7:09 pm
US banks led by JPMorgan Chase are offering a new type of debt product that will help them to skirt new rules requiring them to hold war chests of liquid assets.
The new product is known as “callable commercial paper” and is sold by banks on behalf of US municipalities which use it as a type of financing. The callable version is being openly marketed by at least two big banks as a way for them to bypass new liquidity rules, making it cheaper for them to sell the paper on behalf of munis.
Banks often backstop short-term debt sold by US municipal issuers. When the financial crisis struck, many munis found traditional buyers for their short-term debt disappeared, meaning banks had to step in and buy the paper instead.
To mitigate that risk, the Basel Committee of Banking Supervisors has proposed new rules that require banks to hold a portfolio of liquid assets against such short-term credit commitments. Banks have to hold high-quality assets to cover any credit commitments which could be tapped within 30 days.
The banks say that would make it more expensive to provide the backstops.
To mitigate the expense, banks have created “callable” paper for muni issuers which sell floating-rate debt – currently a $260bn market. Callable CP comes with a longer maturity of up to 200 days but would be redeemed by the issuer before 30 days.
That will allow banks to avoid the liquidity rules, since the paper has a term of 30 days or more, and still make it palatable to money market funds which buy the short-term debt.
“JPMorgan recently introduced . . . [callable commercial paper] to the market that may allow issuers to mitigate [liquidity]-related surcharges,” the bank wrote in a market update after its first such deal.
JPMorgan has used the structure in a $178m deal arranged for the North Texas Tollway Authority in August, followed by a $130m deal for the Municipal Improvement Corporation of Los Angeles in September.
Last week, JPMorgan and Morgan Stanley worked together to place $115m of the paper for the Sunshine State Governmental Financing Commission in Orlando, Florida. At least one other bank said it had been approached by JPMorgan to act as a marketing agent.
Rival public finance bankers added that JPMorgan invented the callable commercial paper structure after working on it for more than a year. The original liquidity rules proposed by the Basel committee suggested that banks would have to hold enough liquid assets to cover a 100 per cent draw down on their credit facilities.
However, new rules released by the committee earlier this month have changed that figure to 30 per cent for facilities provided to public finance entities.
That could dampen demand for callable commercial paper. “The motivation for doing this was just cut by 70 per cent,” said one banker.
Still, bankers said that munis were keen to use the structure since the paper also allows them to spread their maturities, reducing their own funding risk. They estimate that $1bn worth of the paper could be issued by mid-2013 and several billions over the next 15 months.
Moody’s, the rating agency, said in a September report that the new “innovative liquidity structure” was a positive development for munis which issue variable rate debt.
Please don't cut articles from FT.com and redistribute by email or post to the web.
FTfm is the voice of the global fund management industry, providing must-have news and sharp analysis to the world’s top asset managers and professional investors.