While outstanding munis hover around $4 trillion — as they have for the past 15 years — retail growth slowed and banks and insurance companies continued to shed muni holdings in 2024, brought down by many investors selling in the fourth quarter.
"Retail sold [quarter-over-quarter] nearly $40 billion (partially due to tax-loss harvesting); banks and foreign investors also trimmed their holdings by $12 billion and $7 billion, respectively; open-mutual funds and closed-end funds also decreased their muni positions, but their holdings losses were more than offset by exchange-traded funds; property and casualty holdings declined by about $4 billion, while those of life insurers were unchanged," said Barclays strategists Mikhail Foux and Grace Cen.
However, the slowdown and contraction of growth in the fourth quarter does not imply there is dwindling demand for munis, said Pat Luby, head of municipal strategy at CreditSights.
"There's plenty of appetite from investors, but it speaks to the reluctance of municipal issuers to layer on debt because they don't necessarily have free cash flow available to pledge to new debt service, and that's revealed in the sizing of the market," he said.
SMA and retail demand, in particular, remain resilient "because they can wait for maturity (versus liquidating a position) to receive their principal back, seem less prone to withdrawing demand (and thus allowing states and locals to keep borrowing) even when prices are falling," said Matt Fabian, a partner at Municipal Market Analytics.
This suggests SMAs are likely to continue to be "an essential demand component as our market continues to grow, regardless of whether or not crossover and/or total return buyers re-emerge," he said.
The selling in the fourth quarter makes sense if "you look at the path of rates at the end of September," said Kim Olsan, senior fixed income portfolio manager at NewSquare Capital.
September 2024 was the strongest close on yields in six months and then by the end of 2024 yields had backed up 40 basis points, she said.
The fourth quarter also saw a lull around the presidential election. Beforehand, the pace of borrowing was "pretty robust" as market participants decided to frontload supply ahead of the forecasted volatility, but then the election came along and "let some of the air out of the balloon," Luby said.
That contributed to the elevated supply year-to-date — which just surpassed $100 billion, the fastest pace of borrowing ever — due to some leftover appetite, he said.
The market value of munis in the fourth quarter was at $4.097 trillion,
"What's not visible from the [$4 trillion figure] is how much of the market gets called or matures every year," Luby said. "And even though the size of the market is basically unchanged over all these years, there's still an enormous amount of work for portfolio managers to maintain their exposure to the market because about 10% of the market gets called or matures every year."
Household ownership of individual bonds was the largest category of muni ownership at 44.7%, mutual funds at 19.6%, U.S. banks at 11.9% and exchange-traded funds at 3.4%. Life insurance companies own 4.5% and property and casualty insurers own 5.2%.
Household ownership of munis — which includes direct ownership of individual bonds in brokerage accounts, fee-based advisory accounts and separately managed accounts — was at $1.83 trillion, down 2.1% from Q3 2024, but up 3.5% from 2023.
Some of the growth in the household ownership category year-over-year was the movement of "some amount of bonds and exposure out of mutual funds and into SMAs," Luby said.
However, the decline in households' muni holdings does not necessarily mean SMAs, which have seen explosive growth over the past several years, saw a decline quarter-over-quarter, he noted.
The growth of SMAs may be hidden within the household category due to conversion of portfolios of individual bonds into SMAs, so "it's not as visible in these numbers that that's going on," Luby said.
Overall, the value of households' muni bond holdings fell more quarter-over-quarter than the 1.4% decline for the market, suggesting the possibility that individual investors were net sellers, he said.
Even with the fourth quarter market value losses, household muni holdings ended the year with $62 billion larger portfolios than in 2023, nearly as much as mutual funds' and ETFs' combined holdings growth, which, together, saw market value rise by $63.7 billion in 2024, said MMA's Fabian.
The muni market remains "more dependent on retail than ever before, which isn't helping," said Vikram Rai, head of municipal strategy at Wells Fargo.
"Credit concerns across the municipal landscape and decline of management fees have caused direct retail investors to be increasingly interested in parking their cash with mutual funds and SMAs (which are better equipped to assess credit and duration risk) and also ETFs," he said.
Mutual funds owned $804.8 billion in Q4 2024, down 0.5% from Q3 2024 even though net flows for the quarter were $6.5 billion, according to the Investment Company Institute. Mutual funds, though, saw their holdings rise 6.4% from Q4 2023.
ETFs rose 3.3% from the third quarter of last year to $137.6 billion, which included $7.7 billion of net new asset flows, per ICI. ETFs were also up 12.2% year-over-year.
While demand has toggled between direct retail and indirect retail, the "operative word is still retail," Rai said.
While in the past "institutional investors — such as banks, insurance companies and even foreigners — would step in when there was material cheapening in the municipal market, now they provide the fallback or safety-net demand to a much lesser degree," he said.
Therefore, muni performance depends on retail investors, who "spook easily and, at present, seem to be in the throes of a crisis of confidence," he said.
Still, this year appears favorable for retail investors, Olsan said.
"During the ultra-low rate cycle in 2020, the household category finished that year at nearly the same market share as the current period [at around 45%]," she said. "Buyers are now witnessing a cycle of elevated yields, which enhances the probability of ongoing engagement at yields that currently are more than 200 basis points higher from the end of 2022."
Elsewhere, institutional investors continued their streak of shedding muni holdings.
Banks' holdings were at $486.2 billion, down 2.2% quarter-over-quarter and 8.6% from 2023.
Banks holdings compared to the fourth quarter of 2017 — the last quarter before the Tax Cuts and Jobs Act — are down over 15%, said BofA strategists.
Its holdings are down more than 20% since the Fed began its tightening cycle in the first quarter of 2022, but a lesser 14% since the regional bank problems emerged in the first quarter of 2023.
Insurance companies — both life and P&C insurers — were at $396.4 billion, down 0.9% quarter-over-quarter and down 4.3% year-over-year.
"It is not surprising that the ownership of munis by investors not subject to the maximum federal individual income tax rate of 37% fell in the fourth quarter, as tax-exempt yields were rich, compared to comparably rated corporate (and taxable muni) bonds," Luby said.
In the fourth quarter, the BVAL 10-year single-A tax-exempt yield ranged between 45 and 74 basis points lower than the after-tax yield of the single-A corporate benchmark yield, assuming a 21% tax rate.
Since the 2017 tax reform reduced the corporate rate to 21%, "the incentive for U.S. banks, life and P&C insurers to participate in tax-exempt allocations was limited as to the net taxable equivalent yield benefit in a low-rate environment," Olsan said.
"With a higher yield set, raw values have become more attractive to such buyers," she said, noting, recently-issued AAA-rated Guilford County, North Carolina, GO 4s due in 2044 are trading now near 4.15% with a TEY around 5.25% — about 225 basis points higher than where the bond would have priced four years ago.
