Despite all the volatility that permeated the tax-exempt market in the second quarter of 2008, the household sector chased higher absolute yields and increased its ownership of municipal debt by 1.3% to $912.4 billion, compared with $900.4 billion in the prior three-month period, according to quarterly data as of June 30 released by the Federal Reserve Board this week.
Households retained their title as the largest holders of municipal debt at a time when there was $2.661 trillion of muni debt outstanding and heavy uncertainty and volatility stemming from the ongoing fallout from the credit crisis, the lack of liquidity and support in the short-term market on the heels of the collapse of the auction-rate market, as well as the exits of both Bear, Stearns & Co. and UBS AG from the municipal market.
"With excellent absolute yields and terrible stock market returns, we saw individuals as an increasingly important component of market demand," said Matt Fabian, managing director at Municipal Market Advisors, a Concord, Mass.-based independent strategy and consulting firm.
For instance, the quarter started out on April 1 with triple-A insured general obligation bonds due in 2038 yielding a 5.08%, after which they dipped to a 4.70% on May 30, according to Municipal Market Data. As the end of the quarter approached, the same bonds backed up to 5.09%.
Households have been the top holders of municipal debt for the past 12 years, followed by mutual funds and money market funds, property and casualty companies, and commercial banks.
"Mutual funds, money markets, and individuals gained the most market share among muni bondholders: a straightforward response to the volatility that eroded institutional interest and boosted absolute yields," Fabian wrote in his weekly report on the market.
Steady growth by households has typically been supported by heavy reinvestment demand year over year - especially in the second quarter, which coincides with a significant volume of both June 1 and July 1 rollovers, according to analysts.
The market volatility that contributed to making munis more attractive to individual owners also contributed to one of the largest reductions in holdings. Broker-dealers held less municipal debt in the second quarter of the year largely due to the ARS market debacle, after which many hedge funds and tender-option bond programs were forced to unwind major positions, Fabian said.
As a result, broker-dealers decreased holdings by 21.6% to $51.8 billion from $66.1 billion in the first quarter, and by 4.0% from $54 billion in the second quarter of 2007.
Money market funds were the second largest holder of municipal debt in the second quarter as investors sought shelter in short-term instruments. As a result, the funds owned $504 billion, up 26.4% versus the 12-month period ending June 30, 2007, at which time the funds held $398.7 billion. Money market fund holdings grew 6.5% on a year-to-date basis from $473.5 billion. The funds increased their holdings just 1.8% from $495.3 billion in the first quarter of 2008, when there was $2.642 trillion in total municipal debt outstanding.
Mutual funds, meanwhile, were also a prominent holder of municipal debt during the quarter, growing by 3.9% to $394.8 billion from $380.1 billion in the first quarter.
Although analysts said property and casualty companies have curtailed their exposure to municipal debt in recent years following the catastrophic claims that followed Hurricane Katrina, they maintained ownership of $369.1 billion in the quarter - a 0.2% decrease from $369.8 billion in the first quarter.
P&C companies did, however, show a 4.5% increase in ownership from $353.3 in the second quarter of 2007.
Commercial banks decreased their holdings by 0.2% to $202.7 billion from $203.2 billion in the prior quarter, but increased by 6.5% over 12 months compared to $190.3 billion in 2007's second quarter.