Independent Banker - March 2021 - 35

Next: Data can help target your marketing 
are of the BQ variety, it adds back
only 20% of this fi gure. This gives
rise to the term " disallowance " as
it relates to expense deductibility.
The calculation of the penalty
looks like this: (Cost of funds %) X
(Disallowance %) X (Marginal tax
rate %).
One can see that if cost of funds
rises, the penalty rises. When
deposit rates are low, it's not too
big of a punishment. However, if
fi nancing costs return to the 2%
to 3% levels that has been more
the norm, the penalty can increase
geometrically.
For example, a community bank
with a cost of funds of 40 basis points
(0.4%) and a marginal tax rate of
21% will deduct only about 8.4 basis
points from its muni portfolio's taxfree
yield, if the munis owned are
GMs. If cost of funds rises to 2%, the
penalty is 42 bps, which is a wallop.
The penalty on BQ munis is just onefi
fth of this.
Education on Tap
Webinar series continues
ICBA Securities and its
exclusively endorsed broker,
Vining Sparks, will host
the next webinar in the
Community Banking Matter
series on March 16 at 10 a.m.
Central. Dan Stimpson and
Katharine Bray will present
Strategies for an Economy
Set to Emerge from the
Pandemic. Head over to
viningsparks.com to register.
General market
muni publication
Vining Sparks has published
a Strategic Insight,
Considerations for Bank
Purchases of General Market
Municipals. It discusses
the risks and opportunities
from investing in general
market bonds. For your copy,
contact your Vining Sparks
sales rep.
General market advantages
Now for the reasons that many
portfolio managers are presently
ignoring the big " if. " Bond portfolios
have jumped in size by 22% since
the end of 2019, and community
banks have bought all manner of
securities, which historically have
not been staples. First, there are no
size limitations to a GM issue, as
opposed to a BQ, which is capped
at $10 million per issuer per year.
From an absolute supply standpoint,
GMs comprise around 96% of the
muni market. Secondly, investors
can control their credit risk by
performing their due diligence before
and after purchase.
Thirdly, due to the relatively ample
supply of GMs, all things remaining
equal, they usually yield more than
BQs. Portfolio managers are betting
that the head start on tax-equivalent
yields they're enjoying in this low
cost-of-funds era will be enough to
off set the yield erosion once deposits
become more costly to capture.
Comparison shopping
Recently, there were two nearly
identical Texas municipal bond
issues that diff ered in two important
features: issue size and yield. Caddo
Hills Independent School District
and Aubrey Independent School
District both borrowed money over
a number of years; both were rated
AAA by the major agencies. Caddo
Hills, a GM issue, was $49 million,
In 2021, with
liquidity-rich
balance sheets
and very low
funding costs,
many community
banks have gone
headfirst into the
deep end with
GM issues.
while Aubrey, a BQ issue, was
$6 million. The 2036 maturities
were priced to yield 1.4% and 1.2%,
respectively, to a 2030 call date.
If the end investor was a
community bank, and there's a
good chance it was, the GM issue
gives the owner a decent jump
on a potential hike to its cost of
funds down the road. In fact, this
advantage wouldn't disappear until
the bank's cost of funds climbs to
more than 1.2%.
There is more to this story than
we have space to discuss here.
Nonetheless, if your tax-free muni
portfolio is limited to BQ issues, you
may want to investigate whether it's
worth a dip into the general market
pool. In 2021, you'll be in good
company with thousands of other
community banks. 
Jim Reber, CPA, CFA (jreber@
icbasecurities.com), is president
and CEO of ICBA Securities, ICBA's
institutional, fixed-income brokerdealer
for community banks
independentbanker.org Q 35
http://www.viningsparks.com http://www.independentbanker.org
Independent Banker - March 2021

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