Banks Post Longest Retreat From Munis Since 1996 on Tax Cuts

(Bloomberg) -- Some of the biggest U.S. banks have continued to reduce their exposure to state and local government debt, slashing such holdings by $3 billion during the third quarter, after the federal corporate tax cut weakened the appeal of the securities.

The latest reduction was led by JPMorgan Chase & Co. and Bank of America Corp., which together accounted for more than half of the decline in the three months ended in September, according to quarterly filings with the Securities and Exchange Commission. State Street Corp., Citigroup Inc., First Republic Bank, Bank of New York Mellon Corp. and Morgan Stanley also reduced their holdings in the third quarter.

The figures from the big banks suggest that U.S. lenders are on track to pare their investments in tax-exempt bonds for a third straight quarter, which would be their longest-running retreat from the $3.9 trillion market since 1996, according to Federal Reserve Board figures. That has added headwinds to the market because U.S. banks are one of the biggest buyers of municipal securities.

Following are the changes in muni holdings, according to SEC filings:

BankChange in Q3Change Jan-Sept
JPMorgan-$971 million-$4.5 billion
Bank of America-$715 million-$2.2 billion
Morgan Stanley-$398 million-$394 million
BNY Mellon-$294 million-$621 million
State Street-$193 million-$5.1 billion
First Republic-$186 million-$1.5 billion
US Bank-$171 million+$250 million

Citigroup also reduced its exposure during the year by about $2 billion, with $34 million of that during the third quarter. While Wells Fargo & Co. added $69 million of municipal bonds during the quarter, its holdings are still down by about $3.8 billion this year.

Spokespeople for all the banks declined to comment about their holdings.

The pullback was spurred by President Donald Trump’s corporate tax cut, which reduced the advantage of holding municipal bonds instead of higher-yielding securities like corporate debt. As a result, banks cut their holdings of state and local debt by $26.7 billion during the first half of the year, according to the Fed, which is expected to release its third-quarter data in the second week of December.

The diminished demand from the banks likely weighed on the performance of the longest-dated bonds, which the institutions tend to buy. While the overall municipal market has lost 0.23 percent this year, debt maturing in at least 22 years has lost 1.37 percent and is the worst performer among all maturities, according to Bloomberg Barclays indexes.

But the $3 billion drop in the third quarter by the biggest banks signals that the pace of the pullback may be slowing. Those same lenders reduced their municipal holdings by $5.6 billion in the second quarter and by $11.3 billion in the first three months of the year, according to the banks’ quarterly filings.

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