Tax reform propels muni market to largest size since 2013

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PHOENIX - The total amount of outstanding municipal securities in the market rose by $42 billion in the fourth quarter of 2017 to close the year at $3.851 trillion, according to the Federal Reserve's latest Flow of Funds report.

The figure was the highest since the third quarter of 2013, when total outstanding munis were $3.852 trillion.

“I think tax reform played a huge role,” said Stephen Winterstein, a chief municipal strategist at Wilmington Trust Investment Advisors, noting that December 2017 was a record issuance month as issuers hurried to do advance refunding deals they feared they would be unable to do after the end of the year.

Patrick Luby, a municipal strategist at CreditSights, noted that there were $80.6 billion of redemptions in the fourth quarter that need to be factored into the equation, but concluded that the December issuance was still likely a major factor in the year's overall growth of the market.

The fourth quarter total was up from $3.809 billion in the third quarter of 2017, and from $3.840 in the last quarter of 2016.

Bank holdings of munis totaled $571.5, up from $561.9 billion quarter over quarter and from $550.9 in 2016. Banks have become significant purchasers of munis in recent years and the numbers have grown sharply, as bank holdings accounted for less than $300 billion as recently as the final quarter of 2011.

There had been fears that banking rules adopted in 2014 that excluded munis from being classified as high-quality liquid assets would discourage banks from buying and holding munis, but that doesn’t appear to have been the case. Analysts have said banks often find munis attractive because of their performance relative to Treasuries.

A provision included in Senate banking legislation currently under debate would allow investment-grade, readily-marketable munis to count as HQLA. The bipartisan package could move toward becoming law in the next few weeks, sources said, but it would need to be approved by the House first before heading to the president’s desk.

Money market fund holdings increased for the first time in a few quarters, rising to $142.3 billion from $135.1 billion in the previous quarter. Money market funds have followed an opposite trend from banks, having once been a significant holder of municipal securities that fell off precipitously in recent years. Analysts had blamed the trend primarily on low yields. Money market funds held over $200 billion of munis as recently as 2016, and accounted for more than $400 billion back in 2010.

Mutual funds finished the year with $687 billion of munis, up slightly from $680 billion in the third quarter and continuing a general trend of increased holdings in the past couple of years. Mutual funds closed 2016 with $632 billion of munis, and 2015 finished up at $604 billion.

Closed-end funds accounted for $89 billion of munis in the final quarter of 2017, and exchange-traded funds held $30 billion.

Households and nonprofit organizations, generally known as the retail players in the muni market, closed 2017 with $1.57 billion of municipal securities holdings, down a couple of hundred million dollars from the third quarter of the year and also down from $1.67 billion in 2016 and $1.64 billion at the end of 2015. Munis are known as a market with extremely high retail participation, which has drawn increasing attention from regulators in recent years amid attempts to protect less sophisticated investors.

The next release of Fed data is slated for June.

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Secondary bond market Primary bond market Municipal bond funds Munis Federal Reserve Federal Reserve Federal Reserve Washington DC