WASHINGTON — As banks continue their retreat from the municipal market, insurance companies are becoming hungry for the public debt, according to the latest data released by the Federal Reserve.
The data for the third quarter of 2018, released Dec. 6, shows that U.S. bank holdings of munis fell $14.1 billion to $530.7 billion in the second quarter. Insurance companies increased their holdings by $4.7 billion to $549 billion to surpass banks as muni investors, even when factoring in an additional $1.2 billion of municipals held by banks in U.S.-affiliated areas. The numbers demonstrate the continued effects of a new tax code that makes muni ownership less appealing for banks.
U.S.-chartered banks' muni holdings fell every quarter this year from $570.2 billion at the end of 2017, according to Fed data. That’s because the federal tax law overhaul passed late last year cut the corporate tax rate to 21% from 35%, which along with rising interest rates have made munis less attractive relative to alternative investments.
Despite the decline, bank holdings still represent about 14% of the $3.8 trillion muni market. The total market shrank to $3.83 from $3.86 trillion the previous quarter, though it was little changed from the third quarter of 2017.
Property-casualty and life insurance companies jumped past banks into third place in the rankings, trailing only the household sector at $1.62 trillion and funds (including mutual funds, closed-end funds, and exchange-traded funds) at $819.6 billion.
“I think that’s interesting,” said Patrick Luby, senior municipal strategist at CreditSights.
Luby said that insurance companies tend to be longer-term buyers and that their increased participation in the muni market is a positive development, if not actually an answer to the decline in bank appetites for municipal paper.
“Hopefully that will continue,” Luby said of the insurance trend.
Another factor which may be at play is an increasing desire among life-insurance companies to invest in public infrastructure. While property-casualty insurers hold almost $3 billion less of muni bonds than they did at the end of 2016, life insurers have increased their muni holdings to $201.1 billion from $185.2 billion.
A recent report issued by the Teachers Insurance and Annuity Association of America argued that life insurance companies could be poised to play a larger role in public infrastructure investment, including projects financed by munis.
“Given insurers’ focus, projects requiring foresight and years-long commitments can be very well-suited to the general account,” the TIAA report noted.
Luby said that an interesting market development to watch not captured in the flow of funds is the growth of separately managed accounts, or SMAs. SMAs are portfolios of individual securities managed by professionals on behalf of retail customers. They are more customizable than pooled investment vehicles like mutual funds. While SMAs are captured in the Fed’s household sector, there is little official data available about SMA growth.
Citibank estimates that municipal bonds held in SMAs have grown to more than $500 billion from around $100 billion in 2008, and Luby said that most people agree that growth is continuing.
“The growing complexity of the market argues for professional management,” Luby said.
This “professionalization” of the muni market could change the nature of the secondary-market, because SMAs are managed to a benchmark rather than being buy and hold investors like the traditional direct retail market.
“We should see a growing amount of secondary market trading activity,” Luby said.
Foreign holdings of munis rose to $106 billion in the third quarter from under $102 billion in the second quarter of the year, but remained a relatively small slice of the market.
The data for the final quarter of 2018 will be available March 7, 2019.
