WASHINGTON- Bank holdings of municipal securities fell to $555.7 billion in the first quarter of 2018 from $571.5 billion in the final quarter of 2017, a 2.8% decline that is the first in nearly a decade and the largest in more than 30 years. The drop is directly attributable to tax reform, according to experts.
The Federal Reserve released the data as part of its quarterly Flow of Funds report Thursday.
Bank holdings of munis had been growing steadily for many years, with the exception of a brief dip immediately following the financial crisis. But new federal tax law slashing the corporate tax rate to 21% from 35% has made munis less appetizing for banks and could have implications for competitive sales.
"Holdings of municipal securities by financial institutions fell by approximately $16 billion in the first quarter," said Michael Decker, managing director and co-head of the Securities Industry and Financial Markets Association's municipal securities division. "This isn’t surprising given the reduction in banks’ tax rate enacted in December."
“I’m not surprised that they’re down,” said George Friedlander, a managing partner at Court Street Group Research in New York City. Friedlander said the tax law is responsible for the drop in banks’ interest in munis and that this new landscape might hurt competitive sales.
“Banks were always a very important part of the lower coupon market,” Friedlander said, noting that some buyers are not interested in lower coupon bonds.
Matt Fabian, a partner at Municipal Market Analytics, said the decline in the bank sector was the second-largest quarterly decline ever, rivaling the sharp reduction in bank ownership following tax reform in 1986. Bank holdings fell to $176.7 billion at the end of 1987 from $234.5 billion at the end of 1985.
Fabian said declining bank participation means a more homogenous investor pool, which is a negative thing for issuers.
“Banks have provided demand for small bonds and smaller pieces of large bonds,” Fabian said.
The total size of the muni market fell to $3.84 trillion from $3.86 trillion the previous quarter, the Fed data showed.
Analysts said in March that strong late-year issuance accounted for a larger market in the final quarter of 2017 as issuers raced to complete private activity bond and advance refunding deals they feared would be eliminated under the new tax law. Only advance refundings were ultimately terminated.
Friedlander said issuance was lighter this first quarter at least in part because so many PAB deals were done late last year and advance refunding bonds can no longer can be issued.
The household sector dipped slightly to $1.640 trillion from 1.641 the previous quarter, which Friedlander said was stronger than he anticipated and indicates that those investors are reinvesting in bonds.
Money market funds were down to $140.8 billion from $142.3 billion, which Friedlander attributed to a lack of supply.
Mutual funds and closed-end funds both dipped slightly quarter-over-quarter as well, with mutual funds falling to $687.6 billion from $688.1 billion and closed-end funds falling to $87.3 billion from $89 billion in the final quarter of 2017.
Property-casualty insurance companies remained flat at $327 billion from the prior quarter, while life insurance company holdings ticked up to $193.8 billion from $192.7 billion in the last quarter of 2017.
The Fed will next release its next set of data in September.
