Pub. 1 2021 Issue 3

20 | The Show-Me Banker Magazine By Jim Reber ICBA Securities MUNIS FOR THE MANY Taxable municipal bonds have appeal for nearly all community banks. Loan portfolio management webinar ICBA Securities and its exclusive broker Vining Sparks will host its next segment of the 2021 Community Banking Matters webinar series on May 11 at 10 a.m. Central. We will present Balance Sheet Management and Your Loan Portfolio. Visit icbasecurities.com to register. 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. In the 2020 calendar year, fully 30% of municipal bond issues were of the taxable variety. This is a decade-plus high-water mark. Less than 10 years ago, taxable munis were but a blip on the new issue screen. They’d constitute somewhere between 3% and 7% of total new issuances. In fact, the only year that taxable munis exceeded 2020’s volume was 2010, and that was purely a function of the narrow window for issuing Build America Bonds (BABs), a type of taxable munis only available for issue in 2009–2010.