Municipal bond issuance has plummeted in 2011, but bankers say they haven’t panicked or had second thoughts about their commitment to the underwriting business.
Those in the business say they’ve been proactive in looking for opportunities to buttress revenues through other business lines while preparing clients for issuance to revive.
To make up for lower underwriting revenues, the investment banks are doing more trading in the secondary market, bidding more aggressively for competitive deals, and working to help issuers devise solutions for short-term debt that needs to be refinanced in the current challenging environment.
They are offering non-deal-related underwriting services and credit support, including letters of credit. More also are making direct loans to municipalities.
While the banks didn’t want to disclose any numbers, they say as a result of these efforts their revenues won’t be significantly lower. And many said they would be looking to add staff to muni underwriting desks rather than trim them.
JPMorgan’s municipal division is a case in point. Total municipal underwriting at the firm has dropped 52% so far this year, roughly in line with the industry as a whole. It had underwritten $7.4 billion of bonds in 2011 through May 9, compared with $15.6 billion over the same period in 2010, according to Thomson Reuters data.
JPMorgan’s underwriting business finished third in municipal issuance for all of last year, with $46.8 billion by par amount. It ranked second so far this year through May 9.
Paul Palmeri, head of all trading, short-term sales, and capital commitment, said JPMorgan was prepared for lower revenues from underwriting after working to diversify its muni business. “We have a well-diversified business within our municipal division,” he said. “When one part is slow, another area is doing well. It’s helped us through this slower issuance period.”
To weather lean times in the primary market for new bond issues, Palmeri said JPMorgan has sought to remain very active in the secondary market, where outstanding bonds are traded. It has also been active in the short end of the market, whether in the primary or secondary.
The firm has a large credit book and has been committing capital to issuers for years. Recently, direct purchases of floating-rate notes and fixed-rate loans have been well received, according to Palmeri. In addition, he said, JPMorgan has been supporting clients by maintaining orderly markets when there are unsold balances of negotiated transactions and by committing to large purchases of competitive fixed-rate notes and bonds.
So far this year, the investment bank has an estimated 22% share of the competitive long-term fixed-rate market. Last year, the top firm was around 15% of the market, said Robert Servas, head of the fixed-rate syndicate desk at JPMorgan. Numbers from Thomson Reuters bear this out.
“We have focused our efforts and use of balance sheet as a commitment to issuers not only in the negotiated market but the competitive market as well,” Servas said.
Long-term muni bond issuance was down 53% through May 9, compared with the same period last year. Around $66.7 billion of new debt has come to market over that period. That is less than half of the $142.4 billion of new issuance over the same period in 2010, according to data from Thomson.
Volume has fallen for several reasons, industry analysts say. Stressed state and municipal budgets have lead to the postponement, reduction, or outright cancellation of capital projects. The taxable Build America Bond program, part of the federal economic stimulus that expired at the end of 2010, caused issuers to rush to market last year to take advantage of the federal subsidy it provided. A revival of the program could bring a boost in volume.
The meltdown of the bond insurance business has made it harder for lower-rated credits to access the market.
Fears that the market would experience a flood of municipal bankruptcies are subsiding and so far through 2011, state tax revenues have been recovering. But the same cannot be said for local tax revenues, analysts say, causing municipalities to cut spending throughout the year.
Many underwriting desks that gorged at the issuance trough in 2010 have found themselves scaling back their predictions for new-issue volume this year as many issuers remain on the sidelines.
Interest rates have played a role as well. Rising rates in January kept some state and local governments from issuing new debt. But today’s lower rates could bring more issuance to market.
By Friday’s close, the triple-A rated 10-year bond has been stable or falling for 24 straight sessions to reach a low for the year of 2.64%, according to Municipal Market Data. By contrast, in January of this year, 10-year yields reached a 24-month high of 3.46%.
It’s only a matter of time before volume returns, industry analysts say, and firms need to be ready.
“What we see is that you want to keep your team together to be poised for a resurgence in volume,” said John Hallacy, head of municipal research for Bank of America Merrill Lynch. “This is a time when people meet with clients to find out what their needs are on the banking and investor side.”
Siebert Brandford Shank & Co. is taking that approach. The minority-owned firm is concentrating on business development and meeting its long-standing clients, according to Carole Brown, a senior managing director.
And Siebert wants to broaden its client base to reach clients that it couldn’t when primary activity was stronger. The firm is also pushing hard to participate in the competitive market.
“A lot of times, we don’t get in front of all the issuers in the state,” Brown said. “We’re calling on more of the counties and school districts that we haven’t seen.”
Siebert so far this year has about one-fifth of the total issuance it had over the same period in 2010. It has participated in deals worth $693 million through May 9, compared with $3.1 billion over the same period in 2010, according to Thomson Reuters data.
Siebert Brandford ranked 10th in total issuance for all of 2010 with $9.1 billion by par amount. Today it ranks 18th.
“We’ve been busy marketing and working on some deals that have come to market, and responding to requests for proposals and getting ready for the second half of the year,” Brown said.
The financial crisis of 2008-9 continues to affect the public finance market and its players. It capsized Bear, Stearns & Co. and Lehman Brothers Holding Inc., and forced Merrill Lynch & Co. into a union with Bank of America Corp. Smaller firms benefited as top-tier talent suddenly became available and the appeal of working at the big banks was diminished.
The crisis knocked balance sheets out of whack at the largest banks and forced them to scale back on staffing, as well as salary and benefits. Bankers subsequently were laid off or left in large numbers. Smaller firms then got the opportunity to reel in top talent to augment or launch municipal desks at reasonable rates.
Not Bad for Business
Today, the lighter calendar hasn’t necessarily been bad for business at firms with new underwriting desks. For one, they likely have a lower cost structure. And they’re not losing market share, as they’re now trying to crack the market. They have an opportunity to pick their spots to establish their beachhead.
U.S. Bank has a history of serving issuers in the public finance industry in a trust capacity, and as a provider of liquidity and standby bond purchase agreements. Now, about a year after hiring longtime muni pro Richard Kolman as its head of public finance, it has been busy building an underwriting desk.
Kolman, who worked at Goldman, Sachs & Co. from 1978 to 2007, is focusing on constructing a strong short-term bond desk. He brought aboard Thomas Gallo, who spent most of his career at JPMorgan, to lead it.
U.S. Bank is also building out its remarketing book, where it earns fees for pricing variable-rate debt and finding new investors when it’s tendered. And the firm will concentrate on the Midwest and western regions, as well as on higher education and health care — two areas where U.S. Bank already has a footprint in public finance.
“We’ll be in a position to work well with the relationships that the bank has in these areas,” Kolman said.
The new six-person muni finance team at CastleOak Securities LP, a minority-owned New York-based boutique investment bank, plans to compete for senior management business by leveraging its distribution model, according to chief executive officer David R. Jones.
“With six guys focused on specific markets who have relationships, we don’t need to hit a grand slam to make this work,” he said. “We’re focused on getting our fair share of the market, even if it’s down 50%.”
At Wells Fargo, a firm ranked seventh in underwriting by par amount year-to-date through May 9, overall volume for the year is down just 9% compared with the same period in 2010, according to data from Thomson Reuters. While Wells saw just under $4 billion in issuance through May 10 in 2010, it has seen more than $3.6 billion over the same period this year.
The firm’s municipal debt business is up an estimated 15% for the year-over-year period, according to Phil Smith, Wells Fargo’s head of government and institutional banking. As with JPMorgan, diversity has helped the firm manage through the tough issuance environment.
“Our negotiated [business] is down year-over year,” Smith said, “but competitive underwriting is up year-over-year, direct purchase is up dramatically, variable-rate remarketing is up, secondary trading is up substantially.”
Secondary market trading is up because small investors have been purchasing individual bonds, trying to take advantage of buying opportunities created by the cloud of uncertainty hanging over the muni market. In addition, retail investors have for several months been pulling billions of dollars out of muni bond mutual funds. The selling has bolstered trading in the secondary market.
Less volume on the negotiated side has given Wells more time to bid on the competitive side of the business, Smith said. The firm’s competitive profit and loss statement is up an estimated 35% year-to-date over last year’s number, he added. By comparison, the firm’s negotiated P&L is down by at least the same percentage.
Since the financial crisis, Wells Fargo investment bankers have been speaking to issuers about different options for managing debt to free up money for their immediate needs. What was their number-one concern? Ongoing problems with their variable-rate debt.
Wells’ variable-rate business picked up, particularly direct purchases. Roughly three out of five variable solutions have been going the direct-purchase route, Smith said. That has generated a lot of revenue, but Smith declined to estimate how much.
The variable-rate business should be strong for banks that will help issuers extend or replace a tidal wave of bank credit facilities that are due to expire throughout the rest of 2011 and into next year. And direct purchases are a growing part of this renewal business.
Large amounts of variable-rate demand obligations were issued in late 2007 and 2008 following the collapse of the auction-rate securities market and the sting of their accompanying interest rate penalties. Consequently, some issuers, particularly more conservative ones, shunned floating-rate risk for fixed-rate structures. Direct purchases by banks are popular because, unlike LOCs and SBPAs, they don’t fall under the restrictions that federal regulations and capital requirements impose.
“The direct purchase group works with our banking teams to show direct purchase next to variable-rate demand bonds,” Smith said. “We usually put both options before clients, but most clients are picking direct purchase. This year, direct purchase is replacing a lot of lost volume.”
Year-to-date issuance hasn’t dropped dramatically at RBC Capital Markets either. What the firm has lost in volume, it appears to have gained in its underwriting market share and ranking.
The firm did 22% less volume by par amount year-to-date to May 9 than it did over the same period last year. That represents $4 billion over the period this year, against $5.1 billion in 2010, according to Thomson numbers.
RBC moved up one spot this year to sixth place among underwriter volume from Jan. 1 through May 9, compared with the same period last year. Likewise, its market share jumped from 3.6% to 6%.
A few factors fed these results, said Chris Hamel, head of the bank’s municipal finance group. For one, the fiscal year of RBC Capital Markets, the U.S.-based corporate and investment banking arm of the Royal Bank of Canada, begins in November. Thus, it brings to bear in its numbers the strong issuance it saw in the final two months of 2010.
“We’re feeling November and December balances out a bit of the lower volumes of January through April, in our case,” Hamel said.
Second, RBC has a broad base of business. While it does a lot work with larger issuers, it does a fair amount of middle-market business as well, which Hamel said is off less than the larger-issuer business.
Third, the bank has a large and active tax-credit equity business. It has been syndicating low-income tax credits for six years. Finally, RBC has built a student-loan finance business that has been an active area of issuance.
Underwriting volume is off 48% at Morgan Keegan & Co. The firm slid one spot, to ninth from eighth year-to-date to May 9 from the same period one year earlier, according to data from Thomson.
The firm has underwritten $2.1 billion in par amount year-to-date. Over the same period in 2010, it did $4.1 billion.
But Morgan Keegan has been able to make up for the slight volume in the primary market by trading aggressively in the secondary market, according to Jonathan Nordstrom, head trader and managing director of the municipal desk.
To help with the slip in underwriting revenue, Morgan decided to strengthen its marketing arm, Nordstrom said.
“We’re educating customers and helping them get more comfortable with the municipal market,” he said, “specifically credits, risk profile, those kind of things, in order to sell more bonds in the secondary.”