SILICON Valley Bank’s (SVB) roughly US$7 billion municipal bond portfolio could pose a challenge for BlackRock as it starts liquidating the failed bank’s securities, investors say.

The lender’s muni holdings were mostly long-dated bonds with low coupons, according to Nicholos Venditti, senior portfolio manager at Allspring Global Investments, who said he saw the breakdown in a list circulated by dealers.

The bonds fit solidly into a category of debt that got hammered by rising interest rates, the very phenomenon that ultimately helped spur the turmoil in the banking industry. Munis due in 22 years or longer lost 15.6 per cent last year, almost double the decline of the broader market, data compiled by Bloomberg show.

Such bonds are still deep underwater, triggering a tax provision for munis known as the de minimis rule. The measure requires investors to pay higher taxes on debt sold at hefty discounts, should it then appreciate. It’s a backdrop that’s making some money managers still recovering from last year’s pain even more reluctant to dive in.

“Everyone who has owned that stuff still has a fairly fresh burn wound from 2022,” said Venditti. “They own a structure that most of the market is uninterested in.”

Longer maturities have rebounded in 2023 as worries about a potential recession mount. Some of the biggest players in the market have advised investors to buy longer-term issues as short-dated debt has become expensive and volatile.

GET BT IN YOUR INBOX DAILY

Start and end each day with the latest news stories and analyses delivered straight to your inbox.

Sign UpVIEW ALL

Wary market

But many investors remain wary of longer bonds with low coupons after last year’s abysmal performance, making the debt less liquid and dimming its appeal.

“The holdings consist of structure not credit risk, which likely will require deep concession relative to ‘evals’ given liquidity and US de minimis tax risk,” James Pruskowski, chief investment officer at 16Rock Asset Management, said in a note published on Sunday (Apr 30).

He highlighted a bond sold by a Tennessee issuer that he says is Silicon Valley Bank’s largest single tax-exempt muni position. Issued in 2021 when interest rates were still historically low, it has a 1.75 per cent coupon and matures in 2037. The security is valued more than 15 cents on the dollar below the threshold for the tax provision to kick in, data compiled by Bloomberg show.

Under the de minimis rule, if bonds fall below a certain discount to par, a new buyer would see any later increase in price taxed at the personal-income rate, instead of the lower one for capital gains. As a result, bonds near or below that level trade at an even lower price to compensate for the risk of higher taxes.

Unappealing coupons

“Those are going to get punished,” said Chris Brigati, senior vice president of municipal investments at Valley National Bancorp. “Not a lot of people want to load up on a 2 per cent coupon out in 20 years.”

Some two-thirds of municipal issuance this year, tallying by par amount, has a 5 per cent coupon or higher, data compiled by Bloomberg show.

The Federal Deposit Insurance Corporation (FDIC) said last month that BlackRock will sell US$27 billion in securities from Signature Bank and US$87 billion from SVB Financial Group’s Silicon Valley Bank. The asset manager kicked off sales of those assets last month, starting with mortgage-backed securities.

For the muni holdings, the process began on Tuesday with the sale of US$50 million of taxable securities. The FDIC picked up a roughly US$7 billion muni portfolio from Silicon Valley Bank and about US$270 million held by Signature. The Silicon Valley portfolio is the rough equivalent of an average week of issuance this year in the new issue market.

BlackRock would likely spread the sales over a two-week span, Brigati said. Potential buyers may include muni funds with higher-yielding portfolios, opportunistic trading firms and other banks – if they have room to add to positions, he said.

Carroll Kim, an FDIC spokeswoman, declined to comment, as did Dominic McMullan, a BlackRock spokesman. BLOOMBERG