Not since the Tax Reform Act of 1986 more than 30 years ago have we seen such change impacting our market, affecting both the structure of issues that are being offered as well as the composition of investors who are purchasing these issues.

This article is the second article in a four-part series released throughout the year. You can read the first article here: Alternatives to advance refundings.

Changing investor preferences for municipal bonds

The market for tax-exempt bonds is highly dependent upon tax law, and the recent passage of the Tax Cuts and Jobs Act by Congress at the end of 2017 (the Act) resulted in some noticeable changes in investor preferences.Pie chart: holders of outstanding municipal bonds

As Figure 1 indicates, retail investors represent about half of the market for tax-exempt bonds, followed by mutual funds, insurance companies and banks. However, these market segments have changed noticeably over the past several years.

Bank investment declining

From 1992 until 2017, holdings of tax-exempt bonds by banks increased 481% (from $99.5 billion to $578.9 billion), with banks representing the third largest segment of the market at 14.06%.

Since 2017, however, bank holdings of tax-exempt bonds have decreased 17.8% to $475.5 billion, dropping banks to fourth with just 11.59% of the market. Insurance companies have now passed banks and moved into the third spot with 12.13% of the market. This decline in municipal bond holdings by banks is directly attributable to the reduction in corporate tax rates from 35% to 21% following the passage of the Act at the end of 2017. Since most banks are structured as subchapter C corporations, this reduction in tax rate reduced the benefit they receive from the tax-exempt income of municipal bonds.

figure 2 bond holdings by investor type 1

Professional retail investment increasing

Another important change that has happened over the last several years is the rapid growth of professional retail, specifically separately managed accounts (SMAs). Whereas retail investors may purchase bonds in increments as small as $5,000 to $25,000, institutional investors will typically purchase bonds in $500,000 to $5 million

blocks, making sales to retail investors relatively inefficient in comparison. With SMAs, however, professional money managers will purchase bonds in large blocks and then allocate these blocks to various retail accounts they manage. This process allows issuers to access the important retail market, but in a way that is much more efficient than the traditional method.

As a result, sales of tax-exempt bonds to SMAs have grown more than 50% in the last 6 years as shown in Figure 3.

Chart: investors with the largest allocation

The impact of taxable municipal bonds

Since the elimination of tax-exempt advance refundings following the passage of the Act, many issuers have begun issuing taxable municipal bonds to advance refund outstanding tax-exempt bonds. In this low interest rate environment, taxable municipal bond issuance has surged to $46.2 billion in 2019, and indications are this trend will continue throughout 2020 as well.

Since taxable bonds tend to favor investors with lower tax brackets, we would expect corporations, and specifically banks, to be significant purchasers of these bonds. In 2019, we saw this play out as banks showed strong demand for these bonds, and now represent a significant investor segment in the taxable municipal bond market.


The recent change in corporate tax rates has had a significant impact on investor preferences for municipal bonds. While banks overall have decreased their holdings of tax-exempt bonds, insurance companies and professional retail investors have increased their share of this market. At the same time, as issuance of taxable municipal bonds has increased, banks have been a significant investor segment for these bonds.

In this changing environment, it is especially important for issuers to understand the dynamics at work in the market when contemplating a new bond issuance. It’s not just a question of the size, structure and term of bonds to be issued, it’s also whether the bonds should be taxable or tax-exempt and what investors will be targeted in the sale or placement of the bonds.

Within the UMB Bank Investment Banking Division, our public finance bankers provide public entities and private not-for-profit organizations with tax exempt and taxable financing solutions to help meet their capital needs across a myriad of project types. With decades of experience, our public finance bankers provide clients with professional guidance throughout the financing process.

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This communication is provided for informational purposes only. UMB Bank, n.a. and UMB Financial Corporation are not liable for any errors, omissions, or misstatements. This is not an offer or solicitation for the purchase or sale of any financial instrument, nor a solicitation to participate in any trading strategy, nor an official confirmation of any transaction. The information is believed to be reliable, but we do not warrant its completeness or accuracy. There are risks associated with all transactions involving investment securities. As with any investment, please read all offering information, prospectus, or any other required disclosures before initiating any transaction. Past performance is no indication of future results. The numbers cited are for illustrative purposes only. The opinions expressed herein are those of the author and do not necessarily represent the opinions of UMB Bank, n.a. or UMB Financial Corporation. Future results may vary.

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