Independent Banker - July 2017 - 71

Approximate market correction necessary to create similar tax-equivalent
yields*
Maturity in years
8
10
12
15
Decrease in price
4.21%
4.96%
6.68%
8.81%
Increase in taxable yield
0.53%
0.55%
0.68%
0.78%
*Assumes marginal tax rate declines from 35 percent to 15 percent; assumes cost of funds of 2.00 percent; ignores
capital gains tax liabilities.
the contrary: It would enable much
quicker capital formation, or allow
for investment in marketing, technology
and (gasp) compliance, or create
higher after-tax returns. All of which
are beneficial to the industry. Stay
tuned and engaged.
durations will extend, and capital
gains tax liability to future investors
could rear its head.
As many engaged ICBA members
know well, political advocacy is a
necessary and sometimes untidy
endeavor. We can expect lobbyists
for municipal issuers to weigh in on
their opposition to this tax-cut proposal,
because cities, counties and
states will all have costlier debt if
tax rates fall. In our example above,
the tax-free rate of a relatively short
bond would have to rise about 50
If secondary market
prices drop from
premium to discount
territory, durations
will extend, and capital
gains tax liability to
future investors could
rear its head.
basis points (.50 percent) to create a
similar tax-equivalent yield. Stated
another way, municipalities will
have to pay more to borrow.
From a supply standpoint, could
this then create a growth market
for taxable munis at the expense of
tax-frees? It stands to reason. And
if the cost to the federal government
from the BQ loophole declines as the
TEFRA hit drops, does that improve
ICBA's argument for permanently
increasing the size of a BQ issue
above $10 million? I would argue yes.
Strategies will change
Another difference in portfolio management
is a change in the dynamics
for the strategy known as a tax swap.
The tax code allows community
banks to deduct the loss on the sale of
an investment security from ordinary
income and yet avoid income on the
reinvestment of the proceeds if the
" new " bond is a tax-free muni. This
tax advantage allows an investor to
make up that loss at an accelerated
pace. While the benefits will still
exist, that make-up period will have
an extended break-even date, as the
tax savings are less.
What else on a community bank
balance sheet has tax benefits? Bankowned
life insurance (BOLI). BOLI
yields will automatically decline,
much like tax-free munis. One
advantage of a life insurance contract
versus a bond is there is no mark-tomarket
accounting required. Still,
the long duration of a BOLI contract
means the lost effective income will
be around for quite some time.
None of this is to say that a tax cut
is bad news for ICBA members. Quite
Education on tap:
»A tale of two TEFRAs
Vining Sparks, ICBA Securities'
exclusively endorsed brokerdealer,
has published a Strategic
Insight, " A Tale of Two TEFRAs. "
This research report explains
the difference in investing in
bank-qualified municipals versus
general market paper. For your
copy, contact your Vining Sparks
sales rep or visit viningsparks.com
»Bond Academy open
for registration
ICBA Securities will host the
2017 edition of the ICBA Bond
Academy on Oct. 23-24 in
Memphis, Tenn. This event will
equip attendees with the basic
tools to plan, build and maintain
a high-performing investment
portfolio. Twelve hours of CPE
credit are available. To register,
visit icbasecurities.com
independentbanker.org
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Independent Banker - July 2017

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