Buy Side

U.S. Banks Keep Beefing Up Their Muni Portfolios

U.S. banks enjoyed more exposure to municipal bonds at the end of 2012, fueled by increased profitability and revenues looking for a home in the face of declining commercial-loan generation and proposed federal regulations, according to muni experts.

In their ongoing quest to find suitable investments for their available revenues, banks increased their holdings by 22.3% on a cost basis and 23.5% on a fair-value basis in the fourth quarter of 2012, compared to the end of 2011, according to new quarterly data from Thomson Reuters Bank Insight.

At year-end 2012, banks owned $254.01 billion on a cost basis, up from $207.78 billion the year before, and $263.19 billion on a fair-value basis, up from $213.19 billion in 2011, the data showed.

While some of the uptick can be attributed to savings and loan institutions being added for the first time in two decades to the universe of the top 500 U.S. banks that own municipal debt, analysts said banks overall have been striving to increase their muni bond portfolios in recent years - and have done so steadily and successfully since the mid-1990s.

Between 1991 and 2011, only commercial and savings banks were included in the data. Analysts said they would have expected banks' municipal portfolios to increase in keeping with the recent upward trend, even if savings and loans had not been added to the mix.

"Banks have been quite profitable in recent years and continue to sit on a large and growing cash stockpile," said Anthony Valeri, senior vice president of research at LPL Financial. "The combination of regulation and lackluster loan demand has prompted greater investment in high-quality bonds and municipals are a beneficiary of the trend. Treasuries have witnessed similar strong demand from banks, but municipals make a compelling case for purchases given their tax-advantage and attractive relative valuations.

Rick Calhoun, first vice president of sales and trading at Crews & Associates in Little Rock, agreed that the lack of commercial loan demand led to 74% of banks on the top 500 list beefing up their municipal holdings in the past year.

"Every bank in America is chasing loans, but there just aren't enough good loans to soak up excess reserves that continue to increase," he explained. "That is especially true for larger banks located in America's heartland."

He said the low return on alternative investments - such as mortgage-backed securities, corporate bonds, and government agency bonds - was also a driving factor.

"In many cases, the nominal yields on some tax-exempt bonds are actually greater than taxable securities of comparable quality," Calhoun noted.

"If a portfolio manager must choose between a 10-year agency or corporate bond at 2%, or a high-grade bank-qualified bond at 2% that is also tax-exempt, it's a no-brainer," he added.

The growth of banks' municipal portfolios has been ramping up year-over-year, analysts noted, and began picking up steam beginning in 1996 when they held $75.02 billion on a cost basis and $76.81 billion on a fair-value basis.

By year-end 2011, banks held $207.78 billion on a cost basis, an increase of 15.7% over the previous year, and $213.19 billion on a fair-value basis, up 21.2% from the fourth quarter of 2010. As a result, banks were on track to become the third largest holder of municipal debt behind households and mutual funds.

Wells Fargo Bank had the largest muni bond portfolio and the largest increase in that portfolio among the top 500 U.S. banks that own such debt, according to the data. The Sioux Falls, S.D.-based institution held $29.60 billion, up 32.5% or $7.26 billion from the $22.34 billion it held the previous year, which was also a huge jump from just the $1.66 billion it held at year-end 2009.

Citibank, meanwhile, increased its municipal bond portfolio by 19.9%, or $3.23 billion, to $19.52 billion, up from $16.28 billion, and captured the second place ranking and fourth largest increase in 2012.

JPMorgan Chase Bank, whose $16.57 billion muni bond portfolio saw its fourth steady year of growth, achieved third place overall and the second-largest increase in 2012 after it rose 38.4%, or $4.59 billion, up from $11.97 billion at the close of the previous year.

Bank of New York Mellon bested Citi with the third-largest increase in its $6.052 billion portfolio, which rose by 119%, or $3.28 billion, up from just $2.76 billion at year-end 2011. However, due to its size it ranked fifth among the largest portfolios industry-wide.

Meanwhile, State Street Bank & Trust Co. came in fourth with a $7.45 billion municipal debt portfolio, even though it only grew by 6.1%, or $427.3 million in 2011.

Banks with strong profitability sought municipal bonds as an attractive alternative at year end, and continue to view munis as lucrative in the coming year, according to Crews & Associates' Calhoun.

"Some banks on the top 500 list have very low efficiency ratios and their municipal portfolio serves as a cash cow for profitability," he said. "Also, if rates eventually go up, bonds that are booked as held to maturity don't have to be marked-to-market, which could affect a bank's capital requirements."

Meanwhile, other market participants said new regulations will present challenges to banks that ramped up their municipal holdings in general.

"The reinvigorated interest in munis by banks will be tested in 2013 by the more stringent credit due-diligence standards enacted this year by Dodd-Frank," noted Richard Ciccarone, chief research officer and managing director at McDonnell Investment Management.

But not all banks enjoyed the profitability and flexibility to grow their municipal assets over the period.

Emigrant Bank New York, for instance, decreased its portfolio by 51%, or $385 million, to $370.2 million for the quarter. It ranked 52nd out of 500 banks after it grew to $755.2 million at the end of 2011 on the heels of two years of increases.

The 422nd-ranked FirstBank of Puerto Rico San Juan ended a two-year growth cycle and decreased its portfolio by 68%, or $150.6 million, to $70.9 million in 2012, down from $221.5 million previously. U.S. Bank reduced its portfolio by $315.9 million to $6.02 million, down from $6.34 million.




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