WASHINGTON — The total amount of outstanding municipal securities and loans in the market dropped .28% to $3.66 trillion in the first quarter this year from the fourth quarter of last year, as bank holdings rose 1.43% and money market fund holdings plummeted 3.86%.
These are the highlights from the Federal Reserve Board's Flow of Funds report for the first quarter of this year, which was released Thursday.
Outstanding munis in the first quarter of this year decreased to $3.66 trillion from $3.67 trillion at the end of last year and were down 1.9% over a 12 month period.
The decline in outstanding munis has been a trend since the end of 2010, said Michael Decker, managing director and co-head of municipal securities for the Securities Industry and Financial Markets Association.
In the fourth quarter of 2008, outstanding munis peaked at about $3.77 trillion, but have dropped 2.9% through the first quarter of this year.
"The market is shrinking, even if a bit more slowly," said Matt Fabian, a managing director at Municipal Market Advisors. "It makes it less comfortable for buyers because there is more competition."
As for the reasons why, Decker said, "I think many issuers are still wrestling with a kind of anemic recovery and are fiscally not were they were before the financial crisis began. They're de-leveraging," reducing their amount of debt to shore up their finances.
While gross muni bond issuance was strong for part of the period since 2010, that was mostly due to refundings done to take advantage of low interest rates. But new money issuance hasn't kept pace with redemptions and calls, Decker said.
Fabian agreed and said he has determined that 3.4% or about $105 billion of the current outstanding munis will mature before the end of the year and that new issuance won't make up for that.
The drop in money market fund holdings and the increase in bank holdings also are trends.
Money market funds fell 3.86% to $296.4 billion in first quarter of this year from $308.3 billion at the end of last year and were down 5.15% from $312.5 billion in the first quarter of 2013.
Decker said there has been a 42% drop in money market fund muni holdings since the end of 2008 when they were $509.5 billion.
"That trend is likely to continue," he said, adding, "It's a trend directly related to the rise in bank holdings."
"Many issuers have shifted at least part of their variable rate and short-term debt from public market products like variable rate demand notes to bank products like floating rate notes or loans with floating rate components," he said.
VRDNs have liquidity features and can be put back to banks. During the financial crisis, liquidity banks' ratings were downgraded, many below investment-grade, which caused investors to put bonds back to banks and that triggered penalty rates on the VRDNs for issuers. Also letters of credit and other liquidity products became hard to get and expensive.
While that situation has abated somewhat, issuers have found that issuing floating rate notes or taking floating rate loans from banks can be more cost-effective because they don't to pay for remarketing agents or liquidity providers, Decker said.
Fabian added, "Low rates are wearing away many investors" from MMFs.
As money market fund muni holdings have plummeted, bank muni holdings have showed gains. Bank holdings rose 1.43% to $433.1 million in the first quarter of this year from $427.0 million at the end of last year. They have jumped 12.73% from $384.2 billion in the first quarter of 2013.
"This is also a very significant trend," said Decker. "Banks have been getting involved in the municipal market in different ways."
Not only are they providing fixed rate products to state and local governments, but Decker says he has heard anecdotally that some banks are buying fixed-rate muni bonds with maturities as far as 15 years out.
"It's an attractive product for them," he said. Munis have relatively low credit risk and general obligation bonds are particularly attractive under the capital requirements of bank regulators.
Also banks have faced fewer commercial lending opportunities during the recovery because the business sector has not be expanding and, as a result, banks have money to spend, he said.
But Fabian said the increase in bank holdings is the slowest since the first quarter of 2011. "They are not a limitless source of demand," he said of banks.
