Guest Commentary By Larry Wood, The KeyState Companies


A large number of community banks have purchased general   GM munis offer an attractive yield/spread over comparable bank qualified munis, and, up until recently, the historically low-cost-of-funds environment for banks mitigated the federal TEFRA penalty imposed on general market munis. However, the significant increase in interest rates over the past year makes the purchase of GM munis much less attractive, unless banks consider forming an investment subsidiary to hold these munis.


Investment Subsidiaries Offer Solution for Municipal Securities


TEFR BQ TEFRA M TEFR


TEFRA ACT In the early 1980s, Congress enacted the Tax Equity and Fiscal Responsibility Act, which levied a penalty on community banks seeking tax-free income through municipal bonds, limiting the amount of tax-free income earned on these investments. Te federal government felt the banking industry was “double-dipping” — earning tax-free income on munis while enjoying a deductible business expense for interest paid on deposits funding these investments.


GENERAL MARKET VERSUS BANK QUALIFIED MUNICIPAL BONDS To lessen the blow, Congress allowed a smaller penalty, or discount, to be applied for tax-exempt municipal bonds for a newly created subset of the muni market — BQ munis — for municipal bond issuers that issue no more than $10 million in tax-free bonds in any given calendar year. Congress set this qualification to provide a ready market for the “smallest issuers” in the muni marketplace, ensuring steady and permanent demand for those smaller towns and municipalities that qualified.


TEFRA HAIRCUT CALCULATI untion of thr ehree areasreas: TE BQ TE RA-Impa


TEFRA HA RCUT fuf nt o


TEFRA-mpac BQ No Sub GM TEFRA GM TEFRA


Q TEFRA HaFRA H ircut Form B


GM T FR -Impac


GM TEFRA Haircut Formula: 100% (TEFRA disallowance) * 21% (tax rate) * 2% (cost of funds) = 0.42% GM TEFRA-Impact: (2.65% - 0.42%) / (1 – 21%) = 2.23% / .79% = 2.82% TEY GM Not Subject to TEFRA: 2.65% / (1 – 21%) =3.35% TEY (+53bps)


BQ N t Subje t to TEFRA 2 5% RA Ha rcut o mu : 100% (


A-IImpact: (2.45 bject to TEFR


RA Haiircu Formu am la FR -Impa


act:t (2(2.65 GM No S bjej ct tto TEFRA 2 65 GM Not Subject o TEFRA 18 mobankers.com 5


6 % - 0.420 42% FRA: 2.65%


65


FRA: 2.45% (1% / (1 – .79%) 00% (TEFR


FR


42%) / (1 5% / (1


RA disa osalllowanc allowan


%)) = 2 45% / 0. 9% 3 10% disa ow nc


% = 2.382 3 % 0.79 2.45


nce) * 21


1 – 2 %)21% = 2.23% / .79% = 2. % TE 1 – 21%) =3.35% TEY (+53bps)


2 % (tax ra s))


( ax r te))e) * 2% cost 2 82% TEY


2% (cos o fundunds nds


t Form la 20% (TEFR act: (2.45


mula 45% - 0.08%0 08 8% ( AIIRCU CALCULAT ON ALC LATION


funtion of three areas: TEFRA haircut, federal tax rate and bank cost of funds rmu : 20


BQ TEFRA Haircut Formula: 20% (TEFRA disallowance) * 21% (tax rate) * 2% (cost of funds) = 0.08% BQ TEFRA-Impact: (2.45% - 0.08%) / (1 – 21%) = 2.38% / 0.79% = 3.01% TEY BQ Not Subject to TEFRA: 2.45% / (1 – .79%) = 2.45% / 0.79% = 3.10% TEY (+9 bps)


EFRA a rcut ederal RA disa


8%) / (1 – 21%) %


A haircut, fede a tax ratte an band ank cos FR


nd s ow n e) sallowance) * 21 (tax r te


38% / 0.79% 3 01% TE 0 79% = 3.10%


EY 0% TEY (+


21% (tax rate) 2% ( os 79% = 3.0


e)) * 2% (cos 01


st of fun sunds ost


st of f nd +9 bps))


f fun s nds) = 0.08% 0 08% st off d ) = 0. % 0 42%


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