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June 18 (Reuters) - (The following statement was released by the rating agency)
Basel III banking capital requirements are expected to increase borrowing costs across lending segments, and potentially result in diminished availability of bank-provided credit as banks may focus on reducing their exposure to lower rated and more volatile sectors. However, the high credit quality of CEF borrowers (senior debt ratings generally ‘AAA’ by Fitch) as well as the short tenors of their bank borrowings should serve to mute the impact of Basel III relative to other borrowers. That said, Fitch views many taxable CEFs to be over-reliant on short term bank funding which exposes them to a degree of refinancing risk.
In addition, Basel III’s liquidity ratio standards reduce the cost of short-term loans relative to long-term loans. Fitch notes shorter loans are the prime source of funding for taxable CEFs (margin loans, bank lines and reverse repos). Fitch data shows the type of bank financing CEFs are using has become shorter over time - migrating from term loans (typically with 360-day renewal) to evergreen margin loans that renew every day for a specified term (typically 30 to 180 days).
Looking ahead, Fitch expects CEFs to remain an attractive lending segment for banks relative to other borrowers based on favorable credit characteristics and relatively short loan tenors. That said, Fitch views many taxable CEFs to be over-reliant on short term bank funding at a time when bank balance sheets are under pressure and believes it would be a prudent step for the funds to diversify funding channels and ladder debt maturities to reduce refinancing risk.
The special report ‘Basel III to Affect Taxable Closed- End Funding’ is available at ‘www.fitchratings.com’.