? Proposed corporate tax, regulatory reforms more difficult than many expect
? Policy changes could take years to be felt
? Bank managers could still take advantage of diversification opportunities
The two professionals discussed the potential for significant policy changes such as healthcare, corporate tax and regulatory reform, the firm's interest rate outlook and how both factors should influence bank managers' investment approach. S&P Global Market Intelligence spoke with PIMCO's Libby Cantrill, executive vice president and head of public policy, and Chitrang Purani, executive vice president and portfolio manager focusing on financial institutions, on March 23, the day before House Republican leaders withdrew legislation to repeal and replace the Affordable Care Act.
Below is an edited transcript of that conversation.
Libby Cantrill, executive vice president and head of public policy at PIMCO.
Chitrang Purani, executive vice president
S&P Global Market Intelligence: The market has rallied considerably on the hopes of significant policy changes. Are investors appropriately discounting how hard these changes could be?
Libby Cantrill: Our view since right after the election has been one more of skepticism that this really ambitious legislative agenda could be done as quickly, as boldly as many people expected. These issues — healthcare, tax reform, regulatory overhaul — are probably some of the most complicated issues that policymakers can address. Clearly, what you're seeing with healthcare right now is an example of this. Just to put it in context, healthcare under President Obama, when there was unanimity in the party and the president had high approval ratings and high majorities in both chambers, still took 14 months to sign.
It wasn't easy to pass the Affordable Care Act.
Cantrill: No, no. I think people look at these political parties as monoliths but they're not. There are divisions among the parties and given how nuanced these policy issues are, it's not surprising that there are divisions in the party. It would be surprising if there weren't, honestly.
[As Cantrill spoke, Congressional Republicans were signaling that a vote on healthcare reform would be delayed. The next day, they withdrew the legislation.]
Given the realities of how Capitol Hill works and how ambitious the agenda was when they set out, I don't think we're necessarily surprised internally with what we're seeing taking place on Capitol Hill.
Do they have to get through healthcare to tackle anything else?
Cantrill: They can, but there are two obstacles to that. One is the political obstacle because this is a campaign promise of not only President Trump but many Congressional Republicans. I think politically it would be difficult to abandon healthcare at least at this point. The other issue with this is more of a process-related issue. Because they are going to pass healthcare and tax reform via reconciliation, they basically have to do healthcare first before they can pass a budget that will include reconciliation instructions that then allows them to do to tax reform via reconciliation. The benefit of reconciliation is it only requires 50 votes to pass the Senate versus the normal 60. Yes, they can move on to tax reform but they're basically then, I would argue, precluding themselves from addressing healthcare before the mid-term election. And at this point, I don't think they're willing to do that yet.
Do we have anything historically comparable to proposed fiscal stimulus or infrastructure plans that we could look at as a guide?
Cantrill: Infrastructure at least historically has been a bi-partisan issue. But I would say at this point — and things could change — it doesn't look like Congress is going to be able to move on healthcare, tax reform and infrastructure within a calendar year.
The post-election market reaction was almost immediate, with long-term rates surging higher. The Fed has also raised short-term rates. Does that change how you're advising banks?
Chitrang Purani: In short, not really. A combination of the factors may lead to one or two more rate hikes this year, including a continuation of reduction in labor market slack and positive growth momentum. Our view around long-term interest rates is balanced between uncertainty over tax reform and fiscal spending and the direction of global monetary policy and longer-term considerations, including debt and demographics that could potentially anchor the long-term neutral fed funds to a lower point in the past.
Are there greater opportunities at the short end of the yield curve right now? Where are the best opportunities today?
Purani: What we advocate for regional and community banks specifically is to continue using the securities portfolio as a more efficient lever to manage capital, asset/liability and income goals, instead of just focusing on the securities portfolio as a liquidity placeholder for loans. Opportunities there include diversifying away from municipals, which currently comprise two-thirds of the credit exposure in regional and community bank portfolios as well as taking advantage of some diversification across sectors in the asset-backed and commercial-backed markets and select corporate bonds, which can indirectly help broaden the lending footprint.
If I'm a bank in North Carolina, I can get exposure to a large commercial credit in California. And I'm not extending my loan portfolio to a market that I don't know as well, while still putting a high-quality credit on my book.
We've seen community banks continue to build muni exposure and use held-to-maturity portfolios to protect against rate risk. Do you find that many of your clients are waiting for change?
Purani: For the regional and community banks, one of the biggest frictions tends to be a lack of investment infrastructure that enables them to understand different asset classes. This is part of the reason why municipals tend to be a higher concentration because they are familiar with the municipalities and the direct lending footprint. That doesn't mean this is optimal especially in light of uncertainty over tax reform.