Large Bank's Pullout from Tax-Exempts Continued

The 500 largest commercial banks reduced their holdings of municipal bonds by 7.3% during the first half, to $34 billion, according to federal banking reports.

Banking officials attributed the $2.7 billion decline in book value to shortfalls in bank earnings and the market's tidal wave of municipal bond calls. Municipals, useful for reducing taxes, are valuable to most banks only during profitable times.

Chase Chops Back

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

The biggest decline in holdings of tax-exempts was posted by Chase Manhattan Bank. Its portfolio - $700 million at the start of the year - shrank by $163.29 million, or 23%, to $536.72 million by June 30.

The bank had the seventh-largest municipal bond portfolio among the 500 banks at the end of June, down from the second largest in December 1989, when Chase held $1.43 billion.

Chase officials could not be reached for comment. The bank was one of four whose tax except assets fell by more than $100 million during the period.

Tax Law Sparked Shift

The steady exodus of banks from the tax-exempt market is a direct result of the Tax Reform Act of 1986.

The law largely eliminated the 80% deduction of purchase and carrying costs that banks could take for holding tax-exempt bonds. As a result, the supply of municipals available for purchase has dwindled.

Under the 1986 law, banks can receive the 80% deduction only by purchasing "bank-qualified" bonds - bonds of issuers who sell $10 million or less a year. These issues are usually snapped up fast by regional banks, leaving few municipals for money-center banks.

The 500 banks' book-value holdings have dropped steadily over the past few years. They declined 11.3% in 1989, 16% in 1990, and 21% in 1991.

Reports to the Fed

The figure are base 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 reports are filed with federal banking regulators every six months.

The figures were compiled by the Jersey City data services unit of the brokerage information services group of Automatic Data Processing Inc. and by Ferguson & Co. in Irving, Tex. Data for previous years have been revised to reflect mergers and acquisition. The 500 banks in the group are as ranked by assets on June 30.

Continuing Slide

In market value, the banks' holdings declined 7.2% in the first half, to $36.03 billion, from $38.8 billion at yearend 1991. This continued the recent string of declines - 19% in 1991, 16% in 1990, and 10% in 1989.

On a book-value basis, the municipal bond portfolios of the nation's 100 largest banks constituted 56.8% of the top 500's holdings. That was down from 57.3% at the end of 1991 and well below the 61.3% share at yearend 1989 and the 76.2% at yearend 1988.

Municipal bond holdings of the top 100 declined 8.1% in book value during the first half, to $19.35 billion, from $21.06 billion at the end of 1991. The market value declined 7.9%, to $20.55 billion from $22.32 billion.

Dwindling Role

Commercial banks were the largest group of investors in municipals 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 municipals, or 41% of the $365.4 billion of municipals outstanding.

But banks have cut back drastically on their municipal holdings since 1985, when they reached a peak of $231.7 billion.

According to the Flow of Funds Accounts, all commercial banks held just $98.9 billion of municipal bonds on June 30. That was only 8.8% of the $1.13 trillion outstanding and less than households ($581.7 billion), mutual bond funds ($161.1 billion), and property and casualty insurers ($140.7 billion).

Savings and loans 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.

The largest holder of municipal bonds among the 500 banks remained Morgan Guaranty Trust Co. remains with $2.24 billion. Morgan has been No. 1 for three years.

Second was NBD Bank in Detroit, with $1.04 billion.

No other U.S. bank held more than $1 billion of municipals on June 30; six held $1 billion or more at the end of 1989.

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.

Bullish on Bonds

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 $253,000.

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, Chicago.

During the first half of 1992, his bank increased its holdings modestly, from $364 million to nearly $400 million, he said.

La Salle hopes the Clinton administration will raise the volume cap for bank-qualified issuers to $25 million from $10 million, Mr. Lazuka said.

The Bond Buyer is a sister publication of American Banker.

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