Pub. 1 2021 Issue 1

22 | The Show-Me Banker Magazine By Jim Reber ICBA Securities QUESTIONS TO ANSWERS Net Interest Margin in Jeopardy? Here are Some Solutions. To start the year, I’d like to both properly memo- rialize the late, great Alex Trebek and provide some helpful suggestions for investment man- agement for this challenging rate environment in which we find ourselves. And I’d like to do it in the space of this column, so let’s pick up our signaling devices and see what answers we have in front of us. Answer: This segment of themunicipal bond market is being embraced by community banks after being shunned for the last three decades. Question: What are general market munis? General market munis are differentiated from bank qualified (BQ) munis in two ways. First, there is no limit on the size of the issue (BQs are limited to $10 million per issuer, per year). Secondly, the uses of the proceeds in general market munis are virtually limitless; BQs must be for essential services. As to why BQ issues have been favorites of community banks since 1986, they qualify for beneficial tax treatment related to an institu- tion’s cost of funds. This TEFRA application normally creates higher tax-equivalent yields for bank-qualified issues. However, this advan- tage begins to shrink when tax rates and/or cost of deposits decline, and both of these condi- tions have been in play since 2017. The result? Community banks have been buying roughly twice the volume of general market issues vis-à- vis BQs lately. We’ll see if that trend continues if cost-of-funds levels — or marginal tax rates — ever rise again. Answer: Community bank bond strategies have recently begun including these types of mortgage-backed securities (MBS). Question: What are multifamily MBS? All three of themajor housing agencies, GNMA, FNMA and FHLMC, have stepped up their issu- ance of multifamilyMBS in the past five years. Themain reason for the growth is thatmore of us are living in 5+ family dwellings than ever before. Another is that they can offer some structural advantages over generic pass-throughs. For example, many multifamily pools have short state final maturities of seven to 10 years. Anoth- er is that they almost all have some type of pre- payment penalty baked into the structure. While penalties (or “yield maintenance” provisions) are common in commercial real estate lending, they’re almost non-existent for single-family loans. The prepayment protection they afford is especially attractive in yield environments like we have at the present. Answer: These three factors can each help limit prepayment risk on amortizing securities. Question: What are borrowers’ rate, loan size and geography? At the end of the day, there are only a few criteria that can provide tangible protection against wholesale refinancing (read: prepayment risk) in generic MBS. The one with the most causal rela- tionship is the borrowers’ rate (in bondspeak, the “gross WAC”). Obviously, the lower the current 2021 webinar series will commence soon ICBA Securities and its exclu- sive broker Vining Sparks will present a seven-part webinar series, Community Banking Matters. The first event is Feb. 16, 2021, at 10 a.m. Central Time. CPE credit of one hour is offered for each webinar. For more information, visit www.viningsparks.com.