Households and mutual funds should continue to see strong growth in their investments in the municipal market into 1993, while property and casualty insurance companies may not be a key player for the next few years, analysts said after reviewing Federal Reserve data.
Property and casualty insurance companies posted a $1.9 billion decline in tax-exempt assets in the third quarter of 1992, the largest drop among any sector of holders of municipal securities, according to the Fed's Flow of Funds Accounts.
The decline continues a downward trend that began in the second quarter. The two consecutive quarter decreases also reverse a trend of increasing assets for the insurers since 1984.
Meanwhile, households, or direct retail investors, saw the quarter's biggest increase in assets, which grew by $16.7 billion.
Many insurers took heavy hits due to severe weather conditions this year, said Peter Woll, an analyst at Municipal Market Data in Boston. As a result of the losses, which eroded some companies' profits, many firms no longer need to hold tax-exempts commonly used to offset profits.
"The property and casualty insurance companies were aggressive sellers over the last month," Woll said. "They just got a double whammy with these East Coast storms," he added, referring to the recent heavy rains, which were estimated to have caused over $1 billion in damages in the Northeast, and Hurricane Andrew.
"The property and casualty losses that occurred from the weather this year are probably the worst ever," Woll added.
As a result, "the insurance industry and banking are going to be negligible parts of the municipal market for the next few years," he forecast.
Despite the decline in assets in the third quarter, property and casualty insurance companies have managed to hold onto an approximately 12% share of assets in the tax-exempt market, noted David Madigan, director of municipal analytics at Merrill Lynch & Co. Since 1989, the firms have seen $4 billion of growth in municipal assets, he said.
Madigan also has a less pessimistic view than Woll of the role of insurers in the municipal market in the near term. While several insurers have been hit with massive losses due to the weather conditions, some continue to selectively purchase tax-exempts, he said.
"We have seen a few companies move out of the market, but these have been offset by other companies that have been aggressive buyers," Madigan said.
Mutual funds saw a $3.6 billion increase in assets in the third quarter and continue to outpace the insurers as the second largest holder of municipal bonds.
A $1.6 billion drop in assets in money market funds illustrates the steepness of the yield curve, Woll said. This shows a trend of investors willing to take on additional risk to capture higher yields available on longer-term securities, he noted.
Despite a decline in assets, overall assets of tax-exempt money market funds have risen about 32% since 1989, Madigan said.
Meanwhile, assets of commercial banks, savings and loans, and mutual savings banks are stable. Commercial banks had $98.9 billion of tax-exempt assets in the second quarter, savings and loans had $900 million, and mutual savings banks had $1.4 billion.
Hurt by the Tax Reform Act of 1986, which eliminated the 80% deduction they were able to take for holding tax-exempt bonds, commercial banks have steadily cut their holdings of municipals by not replacing them as they are redeemed or mature.
Commercial banks were the largest group of investors in municipal bonds in every year except one from 1965 through 1986, according to the Federal Reserve. Banks were overtaken by households as the largest sector holding tax-exempts in 1987, dropping to third behind property and casualty insurance companies in 1989.
Banks "got money, but it doesn't pay them to buy tax-exempts if they can't get the exemption," Woll said. instead, banks have been strong buyers of U.S. government securities because of the minimal risk involved in holding the securities.
Bank-qualified bonds, which are those of issuers who sell $10 million or less in a year, are generally snapped up quickly by regional banks, leaving few bonds if any for larger money center institutions, Woll said.
"Unless there's a change in the [tax] law, they're really better off to sell their tax-exempts and buy mortgages or corporates. They can afford to buy the taxable return without any concern for taxes," Woll said.
"The only real loser has been commercial banks," said Madigan. Overall, assets of commercial banks fell about $35 billion since 1989, he said.
Tax-exempt assets of brokers and dealers declined modestly, by $700 million in the quarter. Woll said this in part illustrates the caution of dealers.
"This is not an unusual phenomenon. They just do not want the market exposure," Woll said, adding that dealers are being careful due to sizable losses experienced in September when the municipal market declined.
