Some of the biggest U.S. banks have continued to slash their exposure to state and city debt since the federal government cut corporate tax rates, leaving the securities less attractive to the companies.
JPMorgan Chase & Co., State Street Corp., Wells Fargo & Co., Citigroup Inc. and Bank of America Corp. decreased their holdings of tax-exempt bonds by nearly $16 billion in the first half of 2018, according to quarterly filings with the U.S. Securities and Exchange Commission. First Republic Bank and Bank of New York Mellon Corp. also cut their investments.
As the third-largest buyers of state and local government debt, banks are a key source of demand in the $3.8 trillion market. But the federal government's decision to lower corporate levies diminished the tax benefits of the securities, leading banks to reduce their investments for the first time since 2009, according to Federal Reserve Board figures.
While the bulk of the decline began in the first quarter, banks continued to trim their exposure in the three months through June 30, albeit at a slower pace. Barclays estimates the institutions decreased their municipal-debt holdings by nearly $6 billion in the second quarter, according to an Aug. 10 report, following a $15.8 billion drop in the first three months of the year.
The trend may continue as banks shift into other investments that are more attractive than low-yielding municipal bonds since the corporate tax rate was cut this year to 21% from 35 %. The selling of their munis may continue for the rest of the year, said Scott Siefers, a bank analyst at Sandler O'Neill & Partners.
"Maybe it continues for another couple of quarters, then absent any other change you'd probably begin to steady out a little later on," Mr. Siefers said.
Among the biggest banks, State Street reduced its municipal holdings the most, slashing them by $4.9 billion in the first half of 2018 to $4.2 billion. Wells Fargo cut them by $3.9 billion to $57.5 billion, while JPMorgan's were reduced by $3.5 billion to $53.4 billion. Citigroup cut its investments by $2 billion to $20.7 billion. Bank of America lowered its exposure by $1.5 billion, First Republic by $1.3 billion and Bank of New York Mellon by $327 million.
Morgan Stanley's municipal holdings remained about the same. Two banks increased their exposure: Goldman Sachs Group Inc. added $182 million and U.S. Bank boosted its exposure by $414 million.
Spokespeople for all of the banks except US Bank declined to comment. US Bank spokeswoman Molly Snyder had no immediate comment.
The decreased demand likely weighed on the performance of the longest-dated bonds, which banks tend to buy. While the overall municipal market has eked out a 0.29% gain this year, debt maturing in at least 22 years have lost 0.18%, according to Bloomberg Barclays index. That's left the gap between the yields on long- and short-dated debt wider than it is in the Treasury market, where that gap has narrowed.
"Given that banking institutions used to be some of the largest buyers of longer-dated bonds, the muni yield curve will likely remain steeper than it would have been otherwise, given the extreme flatness of the Treasury yield curve," Barclays analysts said in their report this month.