Fear over predictions of hundreds of billions of dollars in defaults on municipal bonds as well as the political turmoil in U.S. state capitals have led to 13 straight weeks of outflows from municipal bond funds.

This has created volatility in a market that was once considered a bastion of safety.

“While many experts argue that the concerns over the municipal bond market are grossly exaggerated, the wounds and losses associated with ‘safe’ bond investments are still very fresh in the minds of many institutional and retail investors," said James Frischling, president and co-founder of NewOak Capital. "The ‘fool me once shame on you, fool me twice shame on me’ idiom appears to have led many muni investors to sell now and ask questions later.”

Although municipal bonds have historically been seen as a safe place to invest over the long term, increasing losses resulting from the downgrades and potential defaults in municipal portfolios has scared away many traditional investors. 

A report in ASR's sister publication American Banker indicated that commercial banks had about $229.1 billion, or 1.6% of their total assets, tied up in municipal securities as of the end of the third quarter, according to the Federal Reserve.  

Among the top banking companies, Citigroup is the largest holder of municipal securities, with about $15.3 billion of the bonds on its books, according to Highline Financial, which is owned by Thomson Reuters

Wells Fargo & Co., U.S. BancorpState Street Corp. and JPMorgan Chase round out the top five in holdings among banks.

“Simultaneous with municipalities being under revenue, budget deficit and rating pressures, the demand for municipal bonds continues to dwindle down,” said Ron D’Vari, CEO and co-founder of NewOak Capital.

According to D'Vari, both retail and institutional investors such as insurance companies have started to pull out of the market. On the retail side, he said that investors have withdrawn over $26 billion since mid-November according to Lipper U.S. Fund.

"As the portfolio losses from CMBS, RMBS, ABS and other credit sectors of taxable institutions have risen, their need for tax-advantaged municipal securities has become redundant," D'Vari said.

On the other hand, some opportunistic investors and private equity firms are getting more interested because of the increased volatility and in some cases, ‘debt-to-own’ angle. 

The dislocation, according to Frischling, in the municipal market has attracted the attention of some very sophisticated buyers. It seems some of these experts are "backing up the truck" to take advantage of the market's fear.  

"Has the prediction of defaults, the protests in state capitals and the fresh memory of unprecedented losses just created one of the single greatest buying opportunities in a market that is typically stable and predictable or are the investors fleeing the municipal bond market going to be proven to be the smartest investors in the room?" he stated.

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