Pub 3 2021 Issue 3

12 | HOMETOWN BANKER | HOMETOWNBANKER.ORG MUNIS FOR THE MANY TAXABLE MUNICIPAL BONDS HAVE APPEAL FOR NEARLY ALL COMMUNITY BANKS. By Jim Reber, President & CEO of ICBA Securities I have some good news for community bank portfolio managers who have grown weary of some or all of the following conditions that have persisted since 2020: • declining portfolio returns • erratic cash flows • call option exposure • paltry yield spreads Chances are, your bank’s portfolio has been affected by at least some of these conditions over the past year. The wild ride in interest rates kept producing surprises for the bond portfolio, and, in truth, about the only thing positive to be said is that prices rose — then declined — over that period. So, banks’ positions have lost value in 2021, but current investment yields have improved, which illustrates the mixed blessing. Over time, one of the enduring determinants of investment performance is sector weighting. More specifically, the more a bond portfolio consists of municipal bonds, the more likely it will have above-peer yields. According to Vining Sparks, as of Dec. 31, 2020, municipal bonds made up 53% of top-quartile community bank portfolios. At the other end of the spectrum, the bottom quartile was only 9% invested in munis. Historically, the amount of munis a bank owns in large part has been determined by a bank’s need to avoid tax liability. Some depository balance sheets have simply not had room for bonds, muni, or otherwise. Others haven’t been profitable enough to worry about that option. Still others, such as S Corps, which pass through their earnings to their shareholders, don’t benefit from tax-free earnings. SUPPLY SHIFT Fast forward to the Tax Cuts and Jobs Act of 2017. Corporate tax rates were reduced around 40%. That was good news for bottom lines, but it lowered the effective yields on all tax-effected assets, such as traditional munis and bank-owned life insurance. Since that time, banks have shed about one-fifth of their tax-frees. Another subtle but significant feature in that legislation was to no longer allow muni issuers to “pre-refinance” their outstanding debt into other, new tax-free issues. These older bonds could only be refinanced into taxable issues going forward. That has had a major impact on the types of munis being issued in the current environment.