Pub. 7 2019 Issue 1

Issue 1. 2019 13 I f there’s one theme for 2018 that has resonated through- out the banking sector, it’s been the system wide liquidity crunch. Most financial institutions are experiencing loan demand that the market hasn’t seen since 2005-06, right before the Great Recession. However, funding these loans has been a challenge. This is a natural phenomenon of the economic cycle. Interest rates, especially on the short end, have been on the rise and the result is less cash flow available to capture better reinvestment rates when deploying assets. It stands to reason that if rates have been significantly rising on the short end of the curve, the corresponding price depreciation of those assets should translate into the biggest losses. However, that’s only what’s happening with the Treasury Curve which remains very flat. Municipals on the other hand, continue to benefit from a much steeper curve, providing value when allocating longer dated Munis (Figure 1). Drew Simmons serves as Senior Vice President at The Baker Group, where he works with community bank needs pertaining to interest rate risk, asset/ liability management, and fixed income portfolio management. He created the firm’s municipal cred- its database, and is a frequent speaker at banking schools and financial seminars. Contact: 800-937-2257, drew@GoBaker.com . Moreover, shorter Munis are holding up quite well in the face of higher short term Treasury rates. The reason for this? Sup- ply. Over the next month, more than $30 billion are scheduled to mature or be called. Compared with only $22.6 billion of issuance coming to the market, this has left investors clamor- ing for product. To date, municipal supply is down about 17% from the same time last year (Figure 2). Need Liquidity? Sell Short Municipals By Drew Simmons, Senior Vice President, The Baker Group The Muni-to-Treasury yield ratios are highlighting this price behavior. Shorter term ratios are nearing the lowest levels on the year. As shown in Figure 3, both the 1yr and 5yr Muni to Treasury ratios are the lowest since September 2017. Historical- ly, bonds are considered rich when the Muni-to-Treasury ratios are below 80% and cheap when they trade above 80%. Finan- cial institutions experiencing liquidity needs should look to shorter term municipal bonds to raise funds. This is especially the case with C-Corp banks at a 21% tax bracket that are seeing negative tax-equivalent spreads to Treasuries for Municipals inside 6yrs. If loan demand isn’t currently a need, buying longer dated Municipals takes advantage of the widest spreads on the curve. n