The nation's 500 largest commercial banks reduced their holdings of municipal bonds by $2.7 billion, or 7%, in the first half of 1992, according to federal banking reports.

Banking officials cited earnings shortfalls and the market's tidal wave of bond calls as key to first-half portfolio erosion.

During the period, $39.38 billion of bonds were refunded, accounting for 34.3% of the $114.87 billion of municipal bond sales, according to Securities Data Co.

Chase Manhattan Bank, the nation's fifth largest bank, posted the biggest decline in holdings of tax-exempts for the first half of 1992. Its $700 million portfolio shrank by 23%, or $163.29 million. The bank had the seventh-largest bond portfolio among the 500 banks at the end of June, down from as high as second in December 1989, when it held $1.43 billion.

Chase officials could not be reached to comment on the bank's municipal portfolio. The bank was one of four whose tax-exempt assets declined by more than $100 million during the period.

Banks' steady exodus from the tax-exempt market is a direct result of the Tax Reform Act of 1986, which, in most instances, eliminated the 80% deduction banks were able to take for holding tax-exempt bonds. As a result, the available supply of municipal bonds for purchase has dwindled, as banks can only receive the 80% deduction by purchasing "bank-qualified" bonds, or those of issuers who sell $10 million or less a year. These issues are usually snapped up quickly by regional banks, leaving few bonds available for larger money-center banks.

In addition, for most banks, municipals are valuable only during profitable times, when strong earnings can be offset with tax-exempt income.

The 500 commercial banks' holdings, in terms of book value, declined 7.3%, to $34.06 billion as of June 30, from $36.76 billion on Dec. 31, 1991.

The 500 banks' book-value holdings have dropped steadily over the past few years. They declined 11.3% in 1989, to $55.48 billion from $62.53 billion in 1988, fell 16% in 1990, to $46.61 billion, and decreased 21% in 1991, to $36.76 billion.

The bank portfolio figures are based on the entries the banks make in their Federal Regulatory Report of Condition under the category "securities issued by states and political subdivisions of the United States." The report is filed with federal banking regulators every six months. The figures were compiled by Automatic Data Processing BISG Data Services in Jersey City and W.C. Ferguson & Co. in Irving, Tex. Data for previous years have been revised to reflect mergers and acquisitions.

The 500 banks in the group are ranked by assets as of June 30. They include credit-card and other specialty banks, even if they do not hold any municipal bonds.

The 500 banks' holdings, in terms of market value, declined 7.2% in the first half of 1992, to $36.03 billion from $38.8 billion on Dec. 3 1. This continued the recent string of declines - down 19% in 1991, from $47.9 billion; down 16% in 1990, from $57.06 billion, and down I 0% in 1989, from $63.27 billion at the end of 1988.

The nation's 100 largest banks, which hold about 57% of the 500 banks' combined portfolios, posted an 8.1% decline in book value, to $19.35 billion from $21.06 billion at the end of 1991, and a 7.9% drop in market value, to $20.55 billion from $22.32 billion. Their share of the 500 banks' book-value portfolio dropped slightly in the first half of 1992, to 56.8% from 57.3% at the end of 1991. That remained well below the 61.3% share that the top 100 had in 1989 and the 76.2% share they had in 1988.

Commercial banks were the largest group of investors in municipal bonds in every year but one from 1965 through 1982, according to the Federal Reserve's Flow of Funds Accounts. In 1980, for example. commercial banks in the United States collectively held $148.8 billion of municipal bonds, or 41% of the $365.4 billion of bonds outstanding.

But banks have cut back drastically on their municipal holdings since 1985, when they reached a peak of $231.7 billion. They were overtaken by households in 1983, property and casualty insurance companies in 1989, and long-term mutual bond funds in 1991. According to the Flow of Funds Accounts, all commercial banks held just $98.9 billion of bonds on June 30 - only 8.8% of the $1.13 trillion of municipals outstanding and less than households ($581.1 billion), mutual bond funds ($161.1 billion), and property and casualty insurers ($140.7 billion).

Savings and loan associations and mutual savings banks, which are not included in the banking totals, held a relatively paltry $2.3 billion of municipals on June 30, according to the Federal Reserve. They have never held more than $4.4 billion of bonds in any year.

Morgan Guaranty Trust Co. remains the largest holder of municipal bonds among the 500 banks, with $2.24 billion - $21.2 billion ahead of the next largest holder, NBD Bank in Detroit, which held $1.04 billion. No other U.S. bank held more than $1 billion of bonds on June 30,, by contrast, six banks held $1 billion or more of municipals at the end of 1989. Morgan has held the top bank-holding slot for the last three years.

After Chase Manhattan, First Eastern Bank of Wilkes-Barre, Pa., had the second-largest decline in holdings in the first half, selling off all but $20 million of its $142 million portfolio.

Stephen Bednarz, vice president of bank investments, said First Eastern liquidated its municipal bond portfolio "strictly for tax considerations." He declined to give more specifics.

Only one bank added more than $50 million of municipals to its holdings in the first half: Investors Fiduciary Trust Co. in Kansas City, which jumped to $81 million from $253,600. This compares with 1991, when four banks added between $50 million and $99 million to their portfolios and one bank added more than $100 million.

Some other banks are trying to hold onto their dwindling supply of tax-exempts.

"We plan on holding what we have. We could use the tax-exempt income," said Walter J. Lazuka, senior vice president of investment portfolios for La Salle National Bank of Chicago. During the first. half of 1992, the bank increased its holdings modestly from $364 million to close to $400 million, the bank official said.

Officials at the nation's 79th-largest bank are hoping that the incoming Clinton administration will raise the volume cap for bank-qualified issuers to $25 million from $10 million, thereby increasing the supply of bonds available for purchase on which banks can take the 80% deduction, Lazuka said.

"We will still be looking to pick some up. If we could buy them in any quantity, we would," he added.

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