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Fifty Million Municipal Bond Fans Can’t Be Wrong!

By Chris Thompson

In 1959, RCA Victor sold a compilation of Elvis Presley’s greatest hits, officially titled “Elvis’ Gold Records.” Later presses added the boldfaced phrase “50,000,000 Elvis Fans Can’t Be Wrong” to the cover and this became the de-facto album title.  The phrase referred to the voluminous record sales the King of Rock ‘n’ Roll amassed to date in his legendary career.  In modern parlance and on any topic whatsoever, it’s not unusual to hear a pundit defend a challenge with the universal justification “50,000,000 Elvis fans can’t be wrong!”

An observer of the municipal bond market could make the same claim. Municipal bonds have been one of the most successful financing tools and investment strongholds of the past century.  Despite post-election hesitations about the relative value of tax-free bonds (if marginal tax brackets are notched lower), occasional muni investors may be surprised to know the municipal bond market shares Elvis Presley’s magnetism … it continues to defy and surpass expectations. But this is nothing new. Consider the following:

  • During the last round of Federal Reserve rate hikes, from 2004-2006, long-term muni bond prices soared while Treasury prices declined. Municipals greatly outperformed the benchmark curve and were recognized as the top-performing asset class.
  • During the Great Depression, there were thousands of muni bond defaults, yet only a few dozen issuers (a rounding error) failed to fully repay their debts.
  • At the height of the Great Recession, financial analysts predicted imminent doom for muni bond investors. Notably, one-time superstar analyst Meredith Whitney (who correctly predicted Citibank’s 2007 dividend cut and the coming financial crisis) told TV’s 60 Minutes, “There’s not a doubt in my mind that you will see a spate of municipal-bond defaults,” which she estimated would amount to “hundreds of billions of dollars.” Oops! The number of muni defaults actually declined from 2010 to 2015, and that guess about hundreds of billions turned out to be hundreds of billions on the high side.
  • Municipal bonds have survived other “bumps in the road,” including world wars, hyper-inflation, high-profile bankruptcies (though rare), foolish arbitrage schemes (Orange County, Calif., and Jefferson County, Ala.), insurance failures, innumerable floods, fires and snowstorms of biblical proportion, sequestration, debt limits and the fiscal cliff budget debate in 2013, which considered capping tax-exempt income at the 28 percent marginal tax rate. Time and again, muni bonds rise and shine through a morass of threats and predictions of doom.

And 2016 was no exception.  Muni fund inflows eclipsed outflows, even though the last two months of the year were decidedly bearish in this regard. But for sage buyers that arrived to feast upon the indiscriminate selling, the post-election conniption proved to be an early Christmas present. A mid-December Wisconsin Bank Qualified General Obligation issue illustrates the advantage:

Aa2 Oconomowoc WI Schools BQ GO

3.50% 4-1-2036/2025 $103.629 3.00%ytc 3.245%ytm

Assuming a 0.75 percent cost of funds and the current top 39.6 percent federal bracket, this issue produces taxable equivalent yields of 4.86 percent to call and 5.27 percent to maturity, which were 220 basis points and 250 basis points of spread, respectively, vs. the Treasury curve.

Now assume funding costs rise 0.50 percent (to 1.25 percent) and President Trump’s tax plan prevails, dropping the top bracket to 33 percent. The resulting estimated taxable equivalent yields become 4.35 percent to the call and 4.72 percent to maturity. Accordingly, spreads drop to 168 basis points and 196 basis points respectively.

In both scenarios, investors have a solid credit earning attractive triple digit spread compared to US Treasuries and a durable income stream with significant call protection.  Additionally, by mid-January, new issues with similar terms and credit profile priced 30-40 basis points lower. Once again, munis surprise to the upside!

“Suspicious Minds” didn’t believe the selloff when the market was “All Shook Up” and checking-in to the “Heartbreak Hotel.” You shouldn’t either. Elvis may have left the building, but munis are here for the long run.

 

Chris Thompson is executive vice president in the Capital Markets Group at Country Club Bank in Kansas City.

 

 

Got Yield?

A challenging bond market has fixed-income investors studying their portfolios.

By Jeffrey P. Goble

It’s December, and it is safe to say it has been another challenging year in terms of the search for yield for bond investors. I think this makes it year number eight for the challenging bond market, which was basically fueled by the Fed’s historic $4.3 trillion quantitative easing program started in November 2008.

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How Much Optionality Is Too Much?

By Jeff Goble
One of the main negatives for bond investors related to falling interest rates  is the fact that any higher-yielding bonds with call options you own may be called away, thus sharply reducing your bond income.

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Try This at Home

By Jeff Goble

This is my 151st  investments column for BankNews and it occurred to me recently that I should be starting to figure out this bank investing game. Please read on.

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Key Traits of the Trusted Partner

By Stephen DuMont

When looking across any industry or sector, one attribute often separates the highest-performing institutions from the rest: the presence of key trusted partners. These trusted partners perform important functions for their higher-performing clients and while the functions they perform may be different, there is one important trait in common. That is, these leading institutions rely upon trusted partners that provide consistent holistic insight informed by their overall knowledge of the client and the key stakeholders impacted by any decision. Any vendor can attempt to sell products in its inventory. The trusted business partner will work closely with the client to identify its goals and then make recommendations based on an understanding of the institution’s unique financial situation. The solutions provided to the client are not constrained by the inventory of their firm, but rather informed by their understanding of their institutional partner.

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Developing Rational Balance Sheet ‘Bogeys’

By Lonnie Harris

Balance sheet management has always been difficult but never more so than in today’s extended low-rate environment. Since December 2008 when the Fed dropped overnight funds to a range of 0-25 basis points, many of the “routine” decisions were replaced with uncertainty and downright confusion. In retrospect, it is apparent that most managers were initially too conservative, as they expected rates to increase almost immediately. This period was followed by impatience and more accurately, market pressure, which has resulted in duration extension in both the loan and investment portfolios, at historically low rates. These phases were not necessarily knee jerks, but it is questionable how much planning and modeling actually preceded those decisions.

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Economic Forecast 2016, Part 2: Headwinds and Tailwinds

By KC Mathews

 

As I mentioned in part 1 of our economic forecast (March BankNews), I expect our economy to continue to grow at a slow and steady pace in 2016, due in part to the several tailwinds and a few headwinds.

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Economic Forecast 2016: The Tortoise or the Hare?

By KC Mathews

We all know of Aesop’s fable, “The Tortoise and the Hare” — a story of two unequal opponents who agree to a race. The outcome appears to be obvious, but in a surprising twist, the ever-so-diligent tortoise perseveres and wins the race. The moral of the story is slow and steady wins the race.

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How Much Will the Fed Be Able to Increase Rates?

By Mark Tranckino 

On Dec. 16, 2015, by unanimous vote, the Federal Open Market Committee lifted the fed funds rate by one quarter point to a range of 0.25 percent to 0.5 percent. It was exactly seven years to the day earlier that the FOMC moved rates to the “emergency” level of essentially 0 percent.

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Are Non-Bank Qualified Municipal Bonds a Bet Worth Taking

By Kevin Doyle

Q: Should commercial banks take the bet and purchase higher-yielding Non-Bank Qualified municipal bonds? Before attempting to answer, several related aspects should be addressed for perspective. (more…)

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