Texas review of big banks could further shrink muni underwriter ranks

With a huge airport bond deal potentially on the horizon, Houston Controller Chris Brown is concerned about bringing the debt to the market in the wake of a crackdown by Texas Attorney General Ken Paxton on compliance with state laws prohibiting governmental contracts with companies, including investment banks, that "boycott"  or "discriminate" against the  fossil fuel or firearm industries.

Notices from Paxton's office over the last three weeks called on Texas municipal bond issuers to make sure underwriters involved in their bond sales are not skirting the laws as his office launched a compliance review involving several big banks and their involvement with the Net Zero Alliance, which seeks a transition to net-zero greenhouse gas emissions by 2050.

Municipal bond underwriters being scrutinized include Bank of America, Barclays, JP Morgan Chase, Morgan Stanley, RBC Capital Markets, and Wells Fargo. So far this year, all are ranked in the top 20 for underwriters in Texas with deals collectively totaling about $13.3 billion, according to Refinitiv data.

Keira Hand

With UBS and Citigroup already barred from muni business with state and local government issuers for flunking the state's litmus tests on fossil fuel and gun policies respectively, Brown said he worries more major investment banks will be banned from Texas deals at the same time Houston could be selling $2.55 billion of new money bonds for its George Bush Intercontinental Airport early next year. 

"What that potentially does is increase issuance costs as a result of decreased competition and it also potentially increases our risk," he said, pointing to the need for banks with substantial excess net capital to handle multi-billion-dollar muni deals and, in the case of taxable debt, have the ability to sell it to prospective overseas buyers.

When Houston this summer sold $756 million of bonds for the airport, two co-managers on the six member syndicate were banks now threatened by the attorney general.

Brown, who is term-limited from running for reelection on Tuesday, said Paxton's move is part of the state's ongoing attack on local control in which Houston and Harris County are often the targets. He also sees the irony of the fossil fuel boycott law possibly harming Houston. 

"We're the energy capital of the world," he said. "We support investing in energy."

Likewise, JP Morgan Chase says it is among the world's largest financiers of fossil fuels, as well as cleaner energy sources.

"JPMorgan Chase makes independent business decisions consistent with the law and based on what will advance the long-term interests of the people we serve — not a political agenda," said Lauren Blair Bianchi, a bank spokesperson. "These misguided policies seek to achieve the opposite at the expense of taxpayers." 

Other big banks under review by Paxton's office declined to comment. RBC Capital Markets pointed to its standing letter on file certifying its compliance with the law. 

Dru Stevenson, a law professor at South Texas College of Law Houston, said municipal officials in Texas are likely to follow "a path of least resistance." 

"They are going to tend to gravitate towards a bank that openly pledges that they are pro-fossil fuel," he said. "It saves you a lot of due diligence." 

Bloomberg News reported at least two banks were dropped from deals since the net zero review was announced Oct. 17. 

Recent larger deals out of Texas included some banks now under review. The North Texas Tollway Authority's $577 million system revenue refunding bond priced Oct. 17 with Barclays as the senior manager with Morgan Stanley and Wells Fargo as co-managers.

A $298.4 million Texas Public Finance Authority general obligation bond that priced Oct. 25 included Morgan Stanley in the underwriting team. In addition to Morgan Stanley, Bank of America, JP Morgan, Barclays, and Wells Fargo are in the authority's 23-member underwriter pool for the fiscal 2024-25 biennium that began Sept. 1.

Lee Deviney, the finance authority's executive director, and Horatio Porter, the tollway's chief financial officer, declined to comment ahead of the closing of their deals. 

In an effort to quell issuers concerns, Paxton's office, which is tasked with determining if state and local bond deals comply with law, advised bond attorneys on Wednesday of a Dec. 1 deadline to include new language in bond purchase agreements that puts the underwriter on the hook should it run afoul of the two laws that took effect in September 2021. 

"If a company is determined to be a boycotter or discriminator after the issuer has entered into the contract, the issuer can proceed to close on its bonds because the contract makes clear that the statutory representations and covenants survive termination, and the company is therefore liable for violating them," according to the advisory from Leslie Brock, who heads the attorney general's public finance division. 

It added banks have a Dec. 1 deadline to submit revised standing letters of compliance with the laws that omit language qualifying in some way an underwriter's verification. 

"On the whole, this is going to be worse for underwriters," a legal source said. "Some of them may be unwilling to enter into bond purchase agreements due to these requirements." 

A pullback could be costly for issuers as Texas voters decide on $26.17 billion of bonds for schools, hospitals, roads, and other local projects in Tuesday's election.

A study last year analyzed eight months of borrowing activity in Texas under the two laws and found interest costs increased by at least $300 million due to less competition as some banks sidelined their underwriting activity in the state. Further shrinkage in the number of big banks could also hurt commercial paper issuance that relies on their letters of credit, according to market participants. 

The firearm industry, which has objected to Bank of America's and Wells Fargo's participation in Texas bond deals, cheered Paxton's efforts.

"We urge Attorney General Paxton to continue to enforce Texas law to protect state taxes from bankrolling 'woke' corporate policies that discriminate against a Constitutionally protected industry," Mark Oliva, managing director of public affairs at the National Shooting Sports Foundation, said in an email.

Wells Fargo, which escaped a ban this summer after a review by the attorney general's office was unable to determine the bank had a policy or practice that discriminates against firearm businesses, headed a $1 billion Texas Water Development Board revenue bond sale that closed just days before the bank was placed on the net zero review.

The attorney general's review comes with the Texas Comptroller's Office already managing a list of boycotters it assembled last year for divestment purposes.

UBS was the only muni investment bank to be included on that list and therefore was barred from deals. Paxton's office ousted Citigroup in January due to its commercial firearms policy. As a result, both were dropped from a $3.52 billion Texas Natural Gas Securitization Finance Corporation taxable bond sale that priced in March.

UBS in October revealed plans to drop negotiated muni underwriting, while Bloomberg News reported Friday that Citigroup is considering shutting down its entire muni operation.

A similar oil and gas industry boycott law enacted in Oklahoma last year landed Bank of America, JP Morgan, and Wells Fargo on that state's boycotter list, resulting in Wells Fargo's resignation in May as lead manager for a $500 million Oklahoma Turnpike Authority revenue bond sale.

Like Texas' law, Oklahoma's statute is primarily aimed at divestment, while prohibiting state and local government contracts valued at $100,000 or more with companies that boycott. At an Oklahoma House hearing on the law last month, State Treasurer Todd Russ voiced support for removing local governments from the law.

"That wasn't the intention of the legislation," he said. "I would highly recommend taking them out."