Community Bankers of Iowa Monthly Banker Update November 2013 | Page 15

Start the Clock

Written By: Jim Reber, President/CEO of ICBA Securities

Municipal Bonds Usually Fall Late in the Year
Just what in the financial sector, you may have asked yourself,
can a community banker rely on these days? Not inflation. It
has remained well below the Fed’s comfort level, even with
historic dollops of monetary stimulus. Not interest rates. They
spiked in the second quarter of the year, even
though the same Fed continued to insist that
we’re miles away from an actual rate hike. Not
loan demand, not deposit availability, not crop
prices, not Congress.

When buying tax-frees, banks almost exclusively buy the subcategory of bank-qualified (BQ) munis. BQs were hatched by
a tax code change in 1986. A bank-qualified muni is one that
is both under $10 million in total issue size and is for essential
services such as schools, infrastructure or utilities.
Portfolio buyers are incented to purchase BQs
since banks can deduct most of the interest cost
related to carrying the bonds. With very few
exceptions, they cannot deduct any of the cost
of general market munis. Also, since the vast
majority are well-secured (usually by ad valorem
property taxes), and because their supply is
restricted, their risk profile is attractive to community banks.

How about this prediction: municipal bonds,
particularly the type community bank portfolio
managers love, are probably going to fall in
price late in 2013. Read on, if you are so inclined, to learn 1.) why this is likely, and 2.) how
you can benefit.
The bank-qualified sector
It is a hallmark of a well-structured community
bank bond portfolio to have a generous dose of
tax-free munis. Usually banks that have onethird or more of their investments in the muni
category have yields in the top quartile of their
peers. This has been the case for at least several decades.

Timing Tip:
BQs usually are
offered at bargain
prices near the
end of the year.

Time pressures
Here’s a tip for savvy portfolio managers: BQs
usually are offered at bargain prices near the
end of the year. The $10 million per annum limit
makes it almost a necessity for some issuers to
tap the market virtually every year. (If a potential
bond issuance can qualify for BQ status, the issuer will almost always prefer that. The general
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