A Word from Arne
On Wednesday, May 5, the SBA announced that, due to the exhaustion of Payment Protection Program (PPP) funds available for general lenders, SBA would no longer accept PPP applications from those institutions. We had heard rumors of this potential situation, and had advised our clients that the program might close earlier than first anticipated. However, many applicants didn’t learn that funding was exhausted until their application submissions were rejected.
If an applicant has an SBA approval number, lenders will be able to honor the valid applications. Note also that the agency has set aside $6 billion for PPP applications still in review status or needing more information due to error codes.
Where does this leave general PPP lenders with pending rejected applications? The SBA has set roughly $8 billion aside for new PPP loans originated by Community Development Financial Institutions (CDFI), Minority Depository Institutions (MDI), and certain other lenders. An interactive resource is available from the FDIC that can help outstanding PPP applicants locate approved CDFI and MDI lenders. We are directing our clients to refer interested businesses to the FDIC's resource. This is probably your best course of action at this time.
Emergency appropriation needed
It is possible that Congress may extend an emergency appropriation to continue the PPP general funding through May 31. We are actively advocating for this, but have no positive news at this time. We will keep you posted.
Restaurants now being served
Recently, the SBA established the Restaurant Revitalization Fund Program. This $28.6 billion program involves direct grants from the SBA to eligible restaurants, bars and other qualifying businesses negatively impacted by the pandemic. The program will begin taking applications on May 24. Application information can be accessed at restaurants.sba.gov.
For answers to questions about COVID relief programs, as well as any other information related to SBA programs, you can always reach out to H&M. As a Preferred Service Provider of the Independent Community Bankers of America (ICBA), our top priorities are community financial institutions and the people they serve. We’re here to help.
Munis for the Many
Taxable municipal bonds have appeal for nearly all community banks
by Jim Reber, President and CEO, ICBA Securities
I have some good news for community bank portfolio managers who have grown weary of some, or all, of the following conditions that have persisted since 2020:
- declining portfolio returns
- erratic cash flows
- call option exposure
- paltry yield spreads
Chances are, your bank’s portfolio has been affected by at least some of these conditions over the past year. The wild ride in interest rates kept producing surprises for the bond portfolio, and, in truth, about the only thing positive to be said is that prices rose—then declined—over that period. So, banks’ positions have lost value in 2021, but current investment yields have improved, which illustrates the mixed blessing.
Over time, one of the enduring determinants of investment performance is sector weighting. More specifically, the more a bond portfolio consists of municipal bonds, the more likely it will have above-peer yields. According to Vining Sparks, as of Dec. 31, 2020, municipal bonds made up 53% of top-quartile community bank portfolios. At the other end of the spectrum, the bottom quartile was only 9% invested in munis.
Historically, the amount of munis a bank owns in large part has been determined by a bank’s need to avoid tax liability. Some depository balance sheets have simply not had room for bonds, muni or otherwise. Others haven’t been profitable enough to worry about that option. Still others, such as S Corps, which pass through their earnings to their shareholders, don’t benefit from tax-free earnings.
Fast forward to the Tax Cuts and Jobs Act of 2017. Corporate tax rates were reduced around 40%. That was good news for bottom lines, but it lowered the effective yields on all tax-effected assets, such as traditional munis and bank-owned life insurance. Since that time, banks have shed about one-fifth of their tax-frees.
Another subtle, but significant, feature in that legislation was to no longer allow muni issuers to “pre-refinance” their outstanding debt into other, new tax-free issues. These older bonds could only be refinanced into taxable issues going forward. That has had a major impact on the types of munis being issued in the current environment.
In the 2020 calendar year, fully 30% of municipal bond issues were of the taxable variety. This is a decade-plus high-water mark. Less than 10 years ago, taxable munis were but a blip on the new issue screen. They’d constitute somewhere between 3% and 7% of total new issuances. In fact, the only year that taxable munis exceeded 2020’s volume was 2010, and that was purely a function of the narrow window for issuing Build America Bonds (BABs), a type of taxable munis only available for issue in 2009–2010.
Now to the afore-promised good news. If your community bank isn’t much invested in munis, taxables could bring some welcome relief to the issues mentioned in the first paragraph. As supply has grown and the interest rate curve has steepened throughout 2021, taxable munis can serve a number of purposes, not the least of which is respectable return. An investor can also now realistically hope for an issue that’s reasonably proximate to its footprint.
Speaking of returns, a high-grade general obligation taxable muni will out-yield a bank-qualified (BQ) issue at any point on the yield curve. As of this writing, a 10-year AA-rated BQ bond will have tax-equivalent yield of about 1.85%, whereas a similar-duration taxable will be about 2.10%. There are a number of reasons for this, including the relative lack of supply of BQ paper. Also, it bears mentioning that S Corp banks, if they’re able to have tax-free income, will recognize higher tax-equivalent yields than their C Corp brethren.
What’s the downside? Just like any other taxable security, municipal bonds will have a higher degree of price volatility than tax-frees. However, the additional price risk is less than it used to be back in the era of 36% marginal rates for C Corps. It’s anyone’s guess what the impact of higher marginal tax rates will be to the tax-free muni market, but on the face of it, higher rates should be supportive of tax-effected assets.
In the meantime, the growing supply of taxable munis should continue to produce attractive yields. The supply, both in absolute dollars and for a given issue (which isn’t limited to $10 million per issuer per year that BQs are), should produce more than adequate liquidity. The benefits and availability of taxable munis should appeal to the many community banks looking for the right combination of risk and reward.
Elimination of Accommodation Option
Historically, SBA has allowed lenders to facilitate a transaction closing by providing “accommodation” interim funding to a borrower. Not anymore without an approved Authorization. The following is from an SBA Standard Operating Procedure that eliminates this option:
“Interim Advances: For loans processed on a non-delegated basis, after an SBA Authorization has been issued, but prior to disbursement, a Lender or an affiliate of the Lender may make interim advances (also known as bridge loans) and SBA loan proceeds may be used to reimburse the interim advances, as long as the interim advances reasonably comply with the terms of the SBA Authorization. Such advances are made at the Lender’s risk. Lender notification to SBA of such advances is not required. See paragraph h.iv.a) above for information on an interim loan processed on a PLP basis.”
A reminder to lenders (especially new clients) who intend to sell SBA loan guarantees. The SBA approves only two interest accrual methods on sold guarantees: Actual 365 or 30/360. Any new SBA guarantees to be sold must comply with one of these choices, even if a different method was used previously.