CDFA Spotlight: Bond Investor Trends By Stan Provus

Preview

This article examines the various classes of municipal bond investors that dominate the municipal marketplace. Future Learning Corner articles will include a review of other areas of tax-exempt bond finance.

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Municipal bond investors may be grouped into three primary classes. These include: (1) retail, consisting of households acting directly or through an intermediary such as trust companies and investment counsel; (2) retail proxies, consisting of bonds funds including closed-end funds, open-end funds, and unit investment trusts; and (3) institutional, particularly property and casualty insurance companies and commercial banks. The principal characteristic of all buyers of municipal bonds is that they are in a sufficiently high tax bracket that they can benefit from the federal tax exemption. At June 30, 2002, outstanding municipal bonds totaled $1,759.5 billion.

Since 1980 there have been significant changes in the percentage of bonds held by various classes of investors. From the early 1960s through 1980, commercial banks buying for their own portfolio were among the major buyers of municipal bonds. By 1980, commercial banks held 37.3% ($149 billion) of outstanding municipal bonds, the largest single class of buyers. Since 1980, commercial banks have shown a decreased demand for municipal bonds. This is due, in large part, to the availability of competing forms of tax shelters and because of tax law changes in 1986, particularly the loss of bank deductibility. Except for small issuers, financial institutions are prohibited from declaring the amount of interest attributable to purchasing or carrying municipal securities after August 7, 1986. In 1986,1987,and 1988, the share of municipal bonds had by commercial banks declined to 27%, 22.1%, and 17.3%, respectively. By 2002, commercial banks held only 6.7% of outstanding municipal bonds.

Since the 1980s, individuals (households) and their intermediaries like bonds funds have accounted for a much larger share of the market. In 1980, households alone held 26.2% of outstanding bonds. By 2002, their share had grown to 38.1%. The share held by mutual funds over this same period grew from 1% to 15.1%. Money-market funds grew at almost the same rate from a 1980 share of outstanding municipal bonds of .5% to a 2002 share of 15.3%.

Until 1980, property and casualty insurance companies were also major purchasers of municipal bonds, with their share reaching 20.2% of all outstanding municipal bonds in 1980. By 2002, their share had declined to 10.2%.

The various classes of bond investors vary depending on the type of bond or project (manufacturing, housing, healthcare, etc.), bond ratings, interest rate modes—variable, auction, fixed, maturity, credit enhancement, among other factors.

Generally, major buyers of privately placed bonds include banks, institutional buyers, insurance companies, and high net worth individuals. Weekly variable-rate demand obligation bond buyers include money market funds (70%), high net worth individuals (20%), and corporations (10%). Auction rate bonds are sold to individuals or their proxies (50%) and institutional investors (50%).

Insured bonds are generally sold to individuals (2-20 year maturities), trust companies, and institutional investors (longer maturities). Non-rated bonds are sold to high net worth individuals, high-yield bond funds, and other institutional investors.

This article is intended to provide accurate and authoritative information in regard to the subject matter covered. The author and CDFA are not herein engaged in rendering legal, accounting or other professional services, nor does it intend that the material included herein be relied upon to the exclusion of outside counsel. CDFA is not responsible for the accuracy of the information provided in this fact sheet. The information provided has been collected from a variety of sources. Those seeking to conduct complex financial deals using the tools mentioned in this document are encouraged to seek the advice of a skilled legal/consulting professional.