Independent Banker - February 2020 - 44

PORTFOLIO
times larger than the taxable muni sector, so it has relatively
better liquidity. As of 2018, the corporate market was
more than $9 trillion and growing, whereas the entirety
of the taxable market is about $485 billion, according to
Bloomberg, or about 12% of all munis.
But corporates also have higher risk-based capital weightings
and a much higher default history. Moody's Investors
Service reports that from 1970 to 2018, rated corporate
bonds had an annual default rate of more than 6% compared
with 0.09% for rated municipals. Corporates have
historically represented about 5% of the typical community
bank bond portfolio.
First, here's a review of a provision in the tax reform
law from 2017. The act lowered corporate tax rates but
also eliminated the ability of issuers to " pre-re " an existing
issue. This was a strategy by which bonds that had higher-than-market
costs were refinanced early by issuing more
debt at lower costs, with the issuer later paying off the old
debt as soon as it could be called away. The sunsetting of the
pre-re strategy applied only to new tax-free debt.
As rates have fallen over the past year, many old bonds
can now be pre-refinanced into taxable munis and still
save the issuer some money. There also continues to be the
shakeout by portfolio managers to right-size the tax-free
segment in the current tax rate environment.
Nearly $70 billion of taxable munis came to market in
2019, almost double that of the year earlier. A lot of the
Education on Tap
2020 webinar series kicks off
ICBA Securities and its exclusive broker Vining
Sparks begin their 2020 Community Banking
Matters webinar series on Feb. 18 at 10 a.m. CDT.
The topic is Positioning the Investment Portfolio
for Performance. One hour of CPE is offered, and
there is no cost to attend. Visit viningsparks.com
to register.
supply has come from the pre-re activity. While some new
demand has come from erstwhile corporate buyers and
erstwhile tax-free investors, it hasn't been enough to soak
up all the new supply of taxable munis. Spreads are near an
18-month high, which is an indication of relative value (see
graph below).
So, if your investment sector weightings can migrate out
of corporates or tax-free munis, the taxable muni sector
bears strong consideration. Supply is ample, yields and
spreads are attractive, credit quality has been quite good,
and this is probably a sector that will continue to grow.
Regardless of tax structure, your institution could be in a
position to take advantage of the taxable muni sector.
Historical spread comparison
100
95
90
85
80
75
70
65
60
55
50
45
40
10-year AA tax muni spread
10-year AA tax corp spread
Source: Bloomberg/Vining Sparks
44 Q ICBA Independent Banker Q February 2020
Yield spread
12/29/17
1/29/18
2/28/18
3/31/18
4/30/18
5/31/18
6/30/18
7/31/18
8/31/18
9/30/18
10/31/18
11/30/18
12/31/18
1/31/19
2/28/19
3/31/19
4/30/19
5/31/19
6/30/19
7/30/19
8/31/19
9/30/19
10/31/19
11/30/19
http://www.viningsparks.com
Independent Banker - February 2020

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