The Federal Reserve has proposed to include conventional mortgages under ‘highly liquid assets’ for liquidity coverage ratio (LCR) purposes.

“The definition of highly liquid assets would ensure that the assets in the liquidity buffer can easily and immediately be converted to cash with little or no loss of value," the Fed stated. "Thus, cash or securities issued or guaranteed by the U.S. government, a U.S. government agency, or a U.S. government-sponsored entity are included in the proposed definition of highly liquid assets.”

According to JPMorgan Securities analysts, although banks have been large sponsors of GNMAs recently, their appetite should soften if this proposal is adopted. The news affirms analysts' view that GNMAs are rich versus their conventional counteparts. Analysts therefore are maintaining their underweight stance in the sector.

The LCR's purpose is to ensure that banks have sufficient liquid assets to cover a ‘run on the bank,’ JPMorgan analysts explained. This ratio is defined as the ratio of ‘high quality liquid assets’ divided by the projected net cash outflows in a 30-day period, analysts said.

The LCR serves as a significant hindrance for the banking industry overall, analysts said. It is hard to project banks’ LCR shortfall precisely, with analysts thinking that the aggregate shortfall can possibly be in the hundreds of billions of dollars for the whole industry.

Banks can satisfy the LCR in two ways. They can term out their short-dated liabilities or they can purchase more highly liquid assets, JPMorgan analysts said.

Liquid assets include mostly unencumbered cash, central bank reserves and government guaranteed assets that have a 0% risk weight.

Government agency securities, including GSE MBS get credit, but are limited to 40% of liquid assets and are subject to a 15% haircut or they only get 85% credit toward being a liquid asset, JPMorgan explained 

 

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