Upholding a recent downward trend that began in early 2011, the household sector continued to pare its holdings of municipal debt in the third quarter, declining by $65.9 billion, or 3.6%, to $1.75 trillion, one of its lowest levels of ownership since 2008, according to new data released last week by the Federal Reserve Board.
Although the latest holdings are down from $1.816 trillion in the prior quarter, households still managed to own nearly half of the $3.719 trillion of municipal debt outstanding as of Sept. 30, according to the data, which was released Dec. 6.
"Even though there has been moderate buying from the household sector, it has been dwarfed by the amount of bonds that were being lost, and net holdings of munis simply declined sharply as a result," wrote George Friedlander, chief municipal strategist at Citi in his weekly municipal market commentary.
He links the "extremely sharp" decline in household ownership to rate shock, as well as investors being averse to extending their maturities and selling their abundance of high-coupon, short-call paper — and consequently being subject to heavy muni bond calls and maturities in recent years in a declining-rate environment.
The third quarter exemplifies the resulting decline in household ownership, which he noted peaked at $1.938 trillion in the first quarter of 2011, but ended that year with $1.864 trillion. He said a reluctance to reinvest redemption proceeds also played a role.
"As muni yields have been pushed lower by declining Treasury yields, light supply, and strong competition from banks and bond funds, direct retail investors have let a disproportionate amount of the proceeds of bond calls and maturities remain in cash," he wrote.
Judging by last year's pattern, if the downward trend continues, history could repeat itself in the fourth quarter of this year, as households ended the third quarter of 2011 with $1.891 trillion, and subsequently declined, closing out the year with $1.864 trillion.
Meanwhile, mutual funds — the second largest category of municipal debt holders — rose $27.1 billion or 4.6% to $612.8 billion — one of highest levels in nearly a decade. By comparison, mutual funds ended the second quarter with $585.8 billion in municipal holdings, which was up from $542.6 billion in the fourth quarter of 2011.
Heading into the last two weeks of September, municipal bond mutual funds saw heightened demand from investors — highlighted by 25 consecutive weeks of inflows as of the week ended Oct. 3 when funds that report their flows weekly recorded inflows of $553 million, according to Lipper FMI.
In the prior week, the funds took in $592 million for the week ended Sept. 26, which was substantially more than the $256 million in inflows for the week ended Sept. 19.
"It is noteworthy that the holdings in mutual funds continue to climb while the household sector has declined," said John Hallacy, a managing director and manager of municipal bond research at Bank of America Merrill Lynch. "The latter is due to bonds being called away by refundings and maturing pre-re's," he explained.
Experts noted that household ownership had grown steady in the last decade — from just $703.4 billion of the total $1.90 trillion outstanding in 2003 through early 2011, experts noted.
Meanwhile, one of the other largest holders of municipal debt — property and casualty companies — remained relatively constant in their ownership quarter over quarter. The sector held $330.1 billion in the third quarter, which was little different from the $329.6 billion they owned in the previous quarter, or the $328.3 billion they held over the same time frame a year ago in the third quarter of 2011.
They also stayed relatively unchanged in the fourth quarter last year, ending 2011 with $331 billion.
Experts said the sector has managed to keep its municipal holdings steady by avoiding the need to sell municipal debt to pay claims.
"Property-casualty insurance company holdings have been flat despite the incidence of natural hazards," Hallacy noted.
Meanwhile, the dip in holdings for money market funds was barely noticeable, as ownership decreased by a mere 0.1% to $271.6 billion, from $271.8 billion previously. A year ago, by comparison, money markets held $291.9 billion of the $3.708 trillion of outstanding municipal debt.
Broker-dealers and government-sponsored enterprises, also took less of a bite out of municipals in the third quarter — owning 6.9% and 6.8% less, respectively. Ownership by broker-dealers fell $2.1 billion to $29 billion, down from $31.2 billion in the prior quarter, while government-sponsored enterprises owned $1.3 billion less to end the quarter with $18.1 billion compared to the $19.4 billion they held in previously.
Overall, the $3.719 trillion in total municipal assets outstanding declined by $13 billion, or 0.3%, from $3.732 trillion in the prior quarter — which was also the total assets outstanding in the fourth quarter of 2011.
"The decline in the total is due to a decline in the long-term component" of the market, Hallacy noted, referring to the decline by $20.2 billion, or 0.7%, in total long-term debt outstanding to $2.914 trillion at the end of the quarter. That was relatively unchanged from $2.934 trillion in the prior quarter — or even $2.917 in the fourth quarter of 2011.
The decline may seem insignificant, but is more noticeable in the face of the 28.3% jump in short-term term debt, which grew by $12.3 billion to $55.7 billion, up from $43.4 billion in the second quarter.
