Liquidating SVB’s $7 Billion MuniBond portfolio proves that Structure matters

Premium Phobia bites Investors as rates rise.

Liquidating SVB’s $7 Billion MuniBond portfolio proves that Structure matters.

In early May 2023, BlackRock Inc. began liquidating the approximate $7 Billion municipal bond portfolio of bank Silicon Valley Bank, and there are two major factors related to the structure of these MuniBonds which are hindering liquidation.

1. Structure

· Most of the MuniBond holdings were long-dated bonds with low coupon structure (like 2% Coupons) which individual investors like to buy at a slight discount because it is easier to understand than premium bonds. The market is not interested in this structure right now.

· MuniBonds with maturities longer than 22 years were hammered in 2022 and lost 15.6% more than double the negative return of intermediate term bonds.

· Before interest rates went up in January 2022, many banks and investment firms sold low coupon bonds to individual investors.

· For example, Silicon Valley Bank’s largest tax-exempt MuniBond position was a Tennessee MuniBond issued in 2021 with a 1.75% coupon and matures in 2037. Remember how low interest rates were in 2021 as the 10 Year US Treasury never yielded higher than 1.74% and yielded as low at 0.94%. This structure of low coupon and high maturity, not credit, hammered this bond as rates moved north.

· In 2023, the 10 year US Treasury has not yielded less than 3.30% for comparison. Based on matrix pricing, this Tennessee bond is valued more than 15 cents on the dollar below the ‘de minimis” threshold.

2. De Minimis Tax Risk

· If an investor buys a heavily discounted municipal bond, the “de minimis” rule might kick in and the market discount is treated as a capital gain for tax purposes.

· Investors lean heavily towards MuniBonds for tax-exempt income, not creating taxable capital gains, and this phenomena further dampens demand.

· The “de minimis” rule states that if the market discount is less than 0.250 multiplied by the number of full years to maturity after acquisition, the market discount is treated as a capital gain.

Takeaway – Structure Matters

· Since the 2008 financial crisis and the ensuing low interest rate period, Watkinson Capital has been promoting the “The Advantages of Paying a Premium” for municipal bonds which include higher cash flows and more protection from rising interest rates.

· Please read our 4 page white paper titled “Addressing Premium Phobia”.

Ask jeff@watkinsoncap.com for a copy of this whitepaper