Yield and spread opportunities in the tax-exempt market in the first half of 2011 led banks to invest a larger portion of their assets in municipal securities compared to the same period last year, according to industry analysts and quarterly data provided by Highline Financial LLC.
As of June 30, commercial and savings institutions increased their municipal investments by 3.9% to $186.64 billion on a cost basis, up from 2.7% in the first half of last year, according to the Austin-based financial information and analytics provider, which focuses on the U.S. banking sector. Cost basis represents the amortized cost of all securities of states and political subdivisions in the United States not held in trading accounts.
“Banks joined the rest of the investor base and grew more comfortable with municipals as we moved through the year,” said Michael Pietronico, chief executive officer at Miller Tabak Asset Management. “That the municipal yield curve remained much steeper than Treasuries during this time may have played a role in the appetite for banks to own tax-free bonds.”
As of June 30, generic triple-A general obligation bonds due in 2041 were yielding 4.35%, while the 30-year Treasury bond was yielding 4.38% — a muni-to-Treasury ratio of 99.3%, according to Municipal Market Data. Triple-A muni yields in 30 years as a percentage of Treasuries were as low as 98.2% and as high as 107% between April 6 and June 30, according to MMD.
“More sophisticated institutions recognized the excellent relative-value opportunity that municipals represented in 2011. Banks likely recognized that value and added to their exposure as needed,” Pietronico added.
In all of 2010, banks held municipal debt totaling $179.62 billion on a cost basis as of Dec. 31 — up 13.7%, the highest yearly increase on record — up from the previous year when they owned $157.99 billion, according to the data.
George Friedlander, chief municipal strategist at Citi, said banks increased their direct private purchases in the municipal sector in 2011 as part of their overall strategic business plans, while they also continued to purchase bank-eligible bonds and bank-qualified bonds that were issued in 2009 and 2010 under the American Recovery and Reinvestment Act.
“Banks made a conscious decision to reallocate a modest proportion of assets away from the paltry yields on high-grade taxables into munis to increase the after-tax yield spread versus their borrowing costs,” he said.
In addition, he said many others continued to purchase taxable municipal bonds even after the sale of new Build America Bonds authorized under the ARRA expired.
In the first half of the year, Citi ranked first among the top 500 bank holders of municipal debt, though it only expanded its portfolio by 0.3% to $14.98 billion from $14.93 billion as of Dec. 31.
Second-place Wells Fargo Bank demonstrated the largest mid-year increase in its muni portfolio, growing 54.8% to $14.80 billion as of June 30, from $9.56 billion at the close of 2010.
Bank of New York Mellon, which ranked 14th among top holders, showed the second-highest increase, boosting its muni portfolio by 107.9% to $1.25 billion from $605 million at the end of 2010.
While Bank of America showed the largest decline in its municipal assets, dropping 31.6% to $3.69 billion from $5.40 billion, it still managed to snag sixth place overall among the top holders.
U.S. banks generally saw solid profits in 2011 largely due to a steady rise in net interest income, banks’ largest revenue component, as a result of a decline in central bank rates and funding costs, according to a recent Deutsche Bank report on bank profitability. In addition, banks have also seen a rebound in trading income due to the broad-based rally in the financial markets following the official end of the financial crisis two years ago, the report said.
Overall, banks have added to their municipal portfolios every year dating back to 1996, when they held a total of $75.022 billion on a cost basis, according to the Highline data. That was up 1.7% from the year before, when holdings dropped 5.5% to $73.80 billion from $78.05 billion in 1994.
