Large numbers of yield-hungry banks have gorged on municipal bonds, and the industry’s overall holdings of the paper have edged up.
Since 2008, when the Federal Reserve lowered its policy rate to close to zero, munis have grown by a percentage point to make up about 8.4% of total securities owned by banks. While munis are still a small component of aggregate bond portfolios in an industry that has traditionally favored securities with federal backing — particularly mortgage bonds — many banks have piled in. Over the same time, the median ratio of munis to total securities has nearly doubled, to 20.6%. (The graphic below shows industrywide statistics by asset-size category, and securities allocations over time for a group of large muni investors. Interactive controls are described in the captions.)
The typical small bank has a far larger allocation to munis that the typical large one. Reflecting the structure of an industry populated mostly by little institutions but where assets are concentrated among the largest, the median ratio for banks with less than $10 billion of assets tracks closely with the median ratio for the industry as a whole.
Among banks with more than $10 billion of assets, however, the median ratio of munis to securities was just 3.3% at Sept. 30. That is a notable increase from 1.7% at the end of 2008, but remains well below the aggregate ratio of 5.2% for the asset-size class. (Some large banks, like Cullen/Frost (CFR), Wells Fargo (WFC) and Zions (ZION), have unusually large muni portfolios, plumping the aggregate ratio for the group.)
Overall, the shift in portfolio weightings has lifted banks’ share of total muni debt outstanding by 3 percentage points since 2008 to 9.4% at Sept. 30, overtaking money market funds’ presence in the market. The inversion mirrors the torrent of cash that has abandoned money funds — more than $1 trillion since 2008 — and materialized in deposit accounts, rerouting the capital available to fund municipalities. (Households are still the largest investors in municipal debt by far, with about 47%, or $1.8 trillion, of the market at Sept. 30.)
To be sure, most banks with large muni portfolios have long been investors in the securities. Of the 3,600 banks where munis accounted for more than 20% of total securities at Sept. 30, about 2,000 also had more than a fifth of their bond portfolios in munis at yearend 2005. Munis made up a larger percentage of bonds at yearend 2005 than they do currently at about 600 of the banks.
The graphic above shows portfolio composition over time at the 100 banks with the largest muni portfolios at Sept. 30 among those with ratios of munis to securities of more than 20%.
At Frost Bank, the principal subsidiary of Cullen/Frost, munis have ticked up in the last two quarters to 30.1% of total securities, but remain below levels at the end of 2009 and 2010.
Nevertheless, ample funding and the search for yield have pushed banks further into a securities class whose outlook largely depends on its tax treatment, a matter of considerable uncertainty because of partisan warfare over the federal budget.