Banks’ holdings of municipal bonds grew to another record in the first half of 2013 as they cashed in on an opportunity for higher yields.
“With the second quarter sell-off in the bond market primarily impacting longer duration issues, the yield spread over marginal funding costs provided by high credit quality, long-duration municipals became quite attractive,” said Craig Thorton, managing director at Stifel Nicolaus & Co. “Bank funding costs are tied to the front-end of the yield curve, which showed little variation during the quarter,” he said. “Consequently, many institutions found the yield spread from existing holdings weren’t impacted by the sell-off, but they could now add bonds at yield levels that hadn’t existed for quite some time.”
As of June 30 commercial and savings banks and savings and loans in the United States owned $275.66 billion on a cost basis -- up 8.5% from the previous period -- and $274.33 billion on a fair value basis -- up 4.2% from the previous period, according to quarterly data of the top 500 U.S banks’ municipal portfolios as provided by Thomson Reuters Bank Insight. The holdings were the most in records dating back to 1991.
The growth comes on the heels of a 22% increase in 2012 and 23% growth in 2011. Banks’ demand for munis was fueled at year end 2012 by increased profitability and a need to invest revenue in the face of declining commercial-loan generation and proposed federal regulations, muni experts said.
While banks continued to expand their presence in the $3.7 trillion municipal industry, the pace of growth declined from the the year-on-year growth rate posted in the prior six months.
Experts said the slower growth could be attributed to a combination of market concerns over low interest rates leading up to June, headline risk stemming talk of possible Federal Reserve Board tapering and credit concerns triggered by Detroit’s impending bankruptcy and Puerto Rico’s financial crisis.
“The slowing in municipal bond asset accumulation by banks is likely due to the low level tax-exempt interest rates had fallen to by the start of 2013,” said Chris Mier, managing director of the analytical services division of Loop Capital Markets. In addition, he said, the fall in municipal bond prices in May and June of 2013 depressed fair value.
Others said market events were a factor in keeping growth below the increases for the 12 months ending Dec. 31.
“Has the erosion in the market’s overall value because of higher rates taken that number down -- perhaps,” said Michael Pietronico, chief executive officer at Miller Tabak Asset Management. He also questioned to what extent the ill effects of Detroit’s bankruptcy and Puerto Rico’s faltering economy had in slowing banks’ participation. “These two events are largely second half 2013 events,” he said.
Still, banks posted record exposure despite the volatility that led some sectors, such as households, to trim their ownership in the face of rising interest rates, a struggling economy, a weak Treasury market, and concern over Fed tapering its economic stimulus. The Fed postponed tapering at its September meeting and maintained the program at $85 billion of purchases a month.
Households -- traditionally the largest holder of municipal debt ahead of banks, mutual funds and insurance companiesowned $1.647 trillion as of June 30, a 7.7% decline over 12 months.
Banks have added to their municipal portfolios every year since 1996 when they held $75.02 billion on a cost basis and $76.81 on a fair value basis.
Wells Fargo Bank increased its holdings mid-year by 13%, or $3.87 billion to maintain the largest portfolio at $33.48 billion.
JPMorgan Chase Bank had the second largest muni portfolio and posted the largest increase as it boosted its holdings by 28%, or $4.64 billion, to $21.21 billion.
Citibank ranked third with its $18.74 billion portfolio, though it posted the largest decline. Citibank’s portfolio fell by 4%, or $777 million, from $19.52 billion at year end.
Fourth-ranked U.S. Bank, which reduced its muni holdings in the two prior years, decreased its holdings by another $282.7 million, or 4.7%, mid-year to $5.74 billion.
Some smaller muni investors, such as Bancorp Bank, experienced extraordinary growth. The Wilmington, Del.-based bank more than doubled its holdings to $338.1 million.
Others decreased their portfolios significantly over six months, including Emigrant Bank of New York, which cut its muni investments for the second year in a row, a 44% reduction to $207.8 million.
Some of the previous growth by banks may have been exaggerated in the statistics, according to George Frieldander, a muni analyst at Citi.
“The net increase over the prior two years at a number of major banks was inflated by the conversion of [letters of credit] to actual holdings of [variable rate demand notes], which showed as an increase in reported holdings,” he explained.
Mier said if banks, going forward, mirror the increases of the first half of 2013 they could come close to 2012’s year-end growth.. “If banks continue to add from July 1 to the end of this year at the same rate as the first six months, the full year change for cost basis is going to be 17%, not 8.5%,” Mier said. “By year’s end, we would not be surprised if banks had accumulated about $300 billion in municipal bonds on a fair value basis for all of 2013,” he added. “This would produce an increase of about 12% -- not the pace of 2011 or 2012 -- but still a fairly rapid pace of accumulation.”
Given the market tone in recent months, banks should be poised to further increase their participation in the municipal market going forward, according to Mier.
“Loop Capital Markets believes that the higher tax-exempt interest rates caused by the Federal Reserve tapering discussion and the influence of the city of Detroit bankruptcy filing, plus the public discussion of Puerto Rico’s woes have elevated tax-exempt interest rates sufficiently to induce banks to pick up the pace once again,” Mier said. “The yield relationship between tax-exempt interest rates and Treasury bond rates is also an incentive to purchase more municipal bonds.”
