A REMEMBER THE MUNIS DON’T GO TO SLEEP ON A PROFITABLE BOND SECTOR BY JIM REBER, PRESIDENT AND CEO, ICBA SECURITIES “As you get older, three things happen: the memory goes, and I forget the other two.” — Erma Bombeck Being one who can empathize with the late, great humorist Ms. Bombeck, I thought it might be interesting to discuss a segment of the fixed-income universe that has served community banking well over the decades. It’s been many months since I’ve covered it for two practical reasons. The first is that it doesn’t present relative value in the current cycle, and the second is that, because of the first, portfolio managers haven’t been buying many of them recently. I’m speaking of the municipal bond market. It is a maxim of community banking that the more munis a bank owns, the higher performing the portfolio will be. This has been true for decades and in whatever part of the rate cycle we’re currently residing. But since we haven’t visited muni-land for a while, now is a perfect time for a sector update, complete with reminders about nuances and opportunities with state and local government bonds. VALUE MEASURES Tell me if you’ve heard this: The interest rate curve is inverted. It’s now been 16 months and counting since we’ve had a positively sloped curve and that includes the muni sector. A buyer has to invest in a 12-year or longer muni to get a higher yield than a one-year bond. Also, the retail sector continues to gobble up the majority of supply, which is barely running in place. A number of governmental borrowers in 2023 have delayed issuance, probably hoping for some relief on rates. Mom-and-pop investors will typically have higher marginal tax brackets than corporations, and that translates into higher tax-equivalent yields — hence the retail demand. The current impact is such that on the short end of the curve (i.e., 10 years and in), munis produce lower tax-equivalent yields than comparable maturity treasuries. In bond-speak, this is known as “trading through the curve.” Although this is an anomaly, it has persisted for most of 2023. Hence, the relative value, or lack thereof. STILL THE FAVORITE Notwithstanding the preceding paragraph, a hallmark of a high-performing bond portfolio remains a high allocation of munis, although that’s changing some. According to Stifel, top-quartile portfolios had 31% of their dollars in munis in June 2023, compared to 42% a year earlier. Interestingly, the top quartile also had a dramatic drop in its effective duration year-over-year from 5.3 years to 4.2. GUEST ARTICLE 16 Community Banker
RkJQdWJsaXNoZXIy MTg3NDExNQ==