A paradigm shift has transformed the municipal bond market in the last four years and RBC Capital Markets, now on the fifth rung of the underwriter ranking ladder, believes it has a firm hold on the new reality.
The shift is known to anyone with a passing knowledge of the market: monoline insurers once wrapped more than half of new issues but now play just a niche role, and their downfall forced the market to transform itself from one governed by rates to one shaped by credits.
But the implications of the shift haven’t been fully digested by the market, according to Chris Hamel, head of municipal finance at RBC.
“Life is a bell curve,” he said. “Municipal clients to varying degrees have observed the challenges of a marketplace with overall less credit availability.”
Most banks with a solid commitment to public finance have bulked up muni research departments in recent years, and RBC has taken the same step. Where it differs, along with a few others, is the extent to which it has built out its credit book to offer issuers balance-sheet solutions in addition to plain-vanilla fixed-rate financing.
“To really play in the top echelons of the municipal market, you need to be a full-service provider of products,” said Mark Maroney, head of municipal capital markets. “Being able to provide full service, both to investors and to issuers, has been a big change in our strategy over the last five to six years.”
The strategy is based on a simple observation. In the monoline-era, issuers could access one of eight triple-A rated insurers and gain easy access to the capital markets. With that support mostly gone, banks have a chance to fill the void.
Hamel considers this chance such an important one in gaining clients that his outlook for other firms is largely governed by evaluating whether they grasp the lesson. Those that do will gain market share; those that don’t, won’t.
Time will tell if that prediction is borne out, but the results from RBC are encouraging. The firm is on track to be the fifth-largest underwriter nationwide this year, skipping up two spots from 2010.
Its market share as book-runner is 5.3% year-to-date, up from 3.6% in 2007, according to Thomson Reuters. Among negotiated issues, it holds a 6.6% market share and has completed more individual deals than any other firm.
And unlike many of its rivals, the bank is among the top financial advisors in public finance. Year-to-date, it ranks fourth nationally, advising on 127 issues worth $4.34 billion.
“No one feeds their family based on rankings,” Hamel said. “But for us, it’s a statement of how far we’ve come and who we now are. We have all the capabilities of other top firms.”
Credit products RBC offers include liquidity support for variable-rate demand notes, a product used by sophisticated issuers seeking to sell long-term debt at short-term, floating rates.
The $300 billion-plus VRDN market has seen liquidity facilities expiring at a record pace this year, offering ample opportunity for highly rated banks to vie for renewals.
RBC has a competitive edge thanks to high credit grades: it boasts Aa1 and AA-minus ratings from Moody’s Investors Service and Standard & Poor’s.
And through its commercial banking parent, Royal Bank of Canada — recently ranked the 11th safest bank in the world and safest in North America, by Global Finance magazine — it can also offer to simply purchase floating-rate notes directly from issuers, a trend that has been growing this year.
Moody’s in February called the increasing use of direct lending to muni issuers a “credit positive” for the entire sector. For issuers, the loans eliminate counterparty and renewal risks. For banks, the loans are safe additions to shrinking portfolios.
“There’s certainly a trend among banks to provide this product in lieu of an unfunded facility,” Maroney said. “It takes a lot of risks off the table for the issuer.”
The product stands in place of issuing a VRDN, which typically requires liquidity support from a bank and relies on continuous demand from the capital markets.
By directly purchasing the note, “the issuer has no exposure to the bank’s credit or interim dislocation in a direct loan,” Moody’s noted, adding that refinancing risks are limited to the maturity date only, rather than every time the interest rate resets.
Exactly how much VRDN support and floating-rate note purchases RBC provides isn’t disclosed, and league tables miss out on much of the activity by ignoring renewals and private deals.
Maroney would only say that RBC has entered the second tier of providers, whereas four years ago it wasn’t even in the third tier.
“It’s one way we provide balance sheet to our clients,” Maroney said of floating-rate notes. “It’s not an open checkbook, it’s very strategic. We’re not out there responding to every request for proposal.”
RBC isn’t interested in lending to municipalities per se, but having a diversity of solutions has a way of garnering clients and allowing the bank to compete at the highest levels, Hamel said.
The build-out of its credit portfolio has helped overhaul the investment bank from a middle-of-the-curve trading institution to a diversified provider of credit, underwriting, remarketing, and advice. But it’s not RBC’s only move.
FROM REGIONAL PRESENCE TO NATIONAL FIXTURE
The firm’s roots in municipal finance go back some 75 years, but the name “RBC” has only been familiar with muni players since 2001. That’s when Royal Bank of Canada closed a deal to acquire Minneapolis-based brokerage Dain Rauscher and began underwriting munis as RBC Dain Rauscher.
From 2001 to 2007, it grew by acquiring regional, boutique firms. It scooped up Boston-based broker-dealer Tucker Anthony Sutro in late 2001, expanded into the Southeast with William R. Hough & Co. in 2003, and took over Ohio’s top public finance firm, Seasongood & Mayer, in 2007.
The strategy evolved when pools of talent spilled into the streets with the outbreak of the financial crisis. As bulge-bracket firms collapsed, merged, or downsized their muni operations, RBC ramped up the hiring. It tapped Maroney from UBS in May 2007, grabbed seven health care bankers from Bear Stearns in June 2008, and added five single-family housing bankers from UBS a month later.
“The financial crisis presented us with an opportunity to recruit from some of the competitors on the league tables in front of us,” Maroney said. “If the strategy from 2001 to 2007 had been acquisitions … the crisis enabled us to recruit some talent that we didn’t have the chance to recruit previously.”
The platform then underwent a permanent shift as the public finance team migrated from the Minneapolis-based wealth management group, dropped the Dain Rauscher name, and joined the capital markets division headquartered at Three World Financial Center in lower Manhattan.
It also integrated muni sales and trading into a global platform. With offices in Toronto, London, Sydney, and Hong Kong, RBC had a network allowing for easy access to international distribution when Build America Bonds flooded the muni market in 2009 and 2010.
The muni team now operates as one virtual business with two reporting lines: Hamel is part of global investment banking, Maroney is part of global fixed income.
The development added to the muni team’s resources and enabled it to focus on larger clients as a growth initiative.
“There was a definitive pivot in 2008, largely as a result of the financial crisis,” Hamel said. “We were able to accelerate our strategy and expedite our focus on the top 500 issuers in the country.”
One large client that took notice was California. It hired RBC as joint lead manager for its $4.5 billion taxable and tax-exempt borrowing in November 2010 — the largest transaction of last year.
The bank continues to service smaller issuers, too. Year-to-date, RBC holds a 6.7% market share for deals worth less than $10 million, ranking it second nationally.
Meanwhile, hiring hasn’t exactly slowed. This year alone it attracted specialists from market leaders including Citi, Morgan Stanley, JPMorgan, Goldman Sachs, and Jefferies.
The muni team is now one of the largest in the country, with nearly 350 professionals in banking and sales, trading, and underwriting, across 26 cities.
RBC believes it now has a permanent place among top underwriters.
“We trade across the curve now, have a dedicated taxable municipal effort, and we’ve added to off-the-run municipal credits,” Maroney said. “I don’t think there’s any product we can’t provide, versus our competitors.”