Households Say Goodbye to Some Munis; Total Falls

For the third consecutive quarter, households continued to shed some of the municipal bonds they own, while the total volume of outstanding muni debt also declined slightly compared to the previous three months, according to new data from the Federal Reserve Board.

Holders of Municipal Debt

In addition, the overall volume of municipal debt outstanding in the third quarter dipped 0.4% to $3.73 trillion from $3.75 trillion in the second quarter. It mirrored the total debt outstanding at the end of the third quarter of 2010.

It’s only the fifth quarter that muni volume shrunk, including the third quarter of 2000 and the second quarter of 2010, according to the Fed numbers.

The latest quarterly volume also came in slightly lower than the $3.79 trillion outstanding in the fourth quarter of 2010.

The Fed recently revised — and increased substantially — the total debt outstanding, as well as the debt held by the different categories of investors when compared to the second quarter.

It also reported that there is often a discrepancy between Fed numbers and those from major Wall Street firms due to counting methods. The central bank estimates the total volume outstanding from the perspective of muni debt holders, while the firms calculate volume from the issuer’s perspective.

Originally, the Fed reported $2.89 trillion of outstanding munis at the end of the second quarter. Low new-issue volume and active early redemption of debt contributed to a decline in volume in earlier quarters.

As of Sept. 30, households — the largest muni debt holder — owned 1.3% less than they did in the previous quarter, reducing their ownership to $1.904 trillion from $1.929 trillion, according to the revised data. That’s also down from the $1.917 trillion of muni debt households held at the end of the third quarter of 2010, and substantially lower than the $1.957 trillion held in the fourth quarter of last year.

While still modest, the three-month and 12-month declines indicate that the household sector was vulnerable to the negative press targeting the credit quality and safety of municipals at the start of 2011, noted Judy Wesalo Temel, director of credit research at Samson Capital Advisors in New York.

The headline risk that permeated the muni sector in early 2011 — such as the appearance of Wall Street analyst Meredith Whitney on “60 Minutes,” former House Speaker Newt Gingrich’s proposal for state bankruptcy, and problems with public pensions — “may have triggered households to sell municipal bonds,” Temel said.

Investor sensitivity was high around the same time as the rising attractiveness of other asset classes, particularly equities, and that competed for their attention, Temel said. As a result, many investors had a change of heart where asset allocation was concerned. For example, in July the S&P 500 rose to 1,353 from 1,257 at the start of 2011, while the Dow Jones Industrial Average increased to 12,724 from 11,577 over the same period, she said.

Households hit a 20-year record high in the fourth quarter of 2010, when they amassed a whopping $1.094 trillion of muni holdings. Other large holders of muni debt increased their ownership in the quarter, but some decreased their holdings over 12 months.

Mutual funds, for instance, held $527.7 billion of munis as of Sept. 30, up 1.5% from $520.1 billion at the end of the second quarter. But overall, their holdings dropped 0.9% over the 12-month period from $532.8 billion at the end of the third quarter of 2010.

Property and casualty companies saw extremely modest increases in muni holdings, but it was growth nonetheless. As of Sept. 30, they held $349.9 billion — up just 0.5% from $348.2 billion in the second quarter. However, like mutual funds, property and casualty holdings declined 1% over 12 months, from $353.5 billion in the third quarter of 2010.

Some, like U.S. chartered commerical banks, saw a noticeable quarterly and yearly increase. Holdings of municipal debt by commercial banks rose 6.5% to $272.8 billion, up from $256.2 billion in the second quarter, and a whopping 20.5% over 12 months to $226.4 billion in 2010’s third quarter.

Life insurance companies, meanwhile, saw a 1.4% rise in ownership to $117.7 billion in the third quarter of 2011, from $116.1 billion in the previous quarter, but a 16.8% rise over 12 months compared to the $100.8 billion they held a year ago as of Sept. 30.

Temel said the increase is attributed to life insurance companies’ purchasing of Build America Bonds starting in 2009, for their characteristics of high quality and long duration. On the other hand, money market funds and broker dealers were among those whose muni holdings decreased quarterly.

Money market funds saw a 4.5% decline in ownership in the third quarter to $292 billion from $305.8 billion in the second quarter, and a 12.3% decline over 12 months from $333 billion a year ago, as of Sept. 30.

Broker-dealers saw a 9.8% drop in holdings to $36.6 billion from $40.6 billion at the end of the second quarter and a 6.6% drop over 12 months to $39.2 billion as of Sept. 30, 2010, according to the Federal Reserve data.

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