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Banks’ Biggest Local-Debt Bet Since ’85 Fuels Rally: Muni Credit

October 01, 2012

Banks’ Biggest Local-Debt Bet Since ’85 Fuels Rally

Wells Fargo, based in San Francisco, increased state and local debt to about $40 billion from $18 billion in the period. Photographer: Noah Berger/Bloomberg

JPMorgan Chase & Co. (JPM:US), Wells Fargo & Co. (WFC:US) and PNC Financial Services Group Inc. (PNC:US) are leading U.S. banks making the biggest bet on municipal debt in 27 years, helping fuel the longest rally in state and local bonds since 2001.

Banks nationwide held $330 billion of munis as of June 30, a $20 billion quarterly increase, Federal Reserve data show. It was the biggest jump since the end of 1985, according to Municipal Market Advisors, an independent research company.

The purchases reflect the securities’ relative safety, which helps banks meet regulatory requirements. Munis are on a pace to beat Treasuries and corporate debt for a second-straight year when adjusting for volatility, data compiled by Bloomberg show. Local-debt yields have also been above federal interest rates on average for the past two years.

“As long as those two dynamics stay in place, this trend is probably here to stay for a while,” said Peter Hayes, a managing director at New York-based BlackRock Inc., which oversees about $105 billion of munis. The demand has fueled increased bidding for localities’ debt, he said.

The banks have eclipsed property and casualty insurers as the third-largest investors in the $3.7 trillion muni market, behind households and mutual funds, Fed data show. Their increasing appetite has helped depress borrowing costs for states and cities that are still under fiscal pressure three years after the worst recession since the 1930s.

Longest Rally

Munis gained the past seven quarters, the longest stretch since 2001, according to Bank of America Merrill Lynch data.

After accounting for price swings, state and city debt has earned about 3.5 percent this year through Sept. 27, compared with a 2.5 percent risk-adjusted gain for corporates and 0.7 percent for Treasuries, data compiled by Bank of America and Bloomberg show.

“It’s probably one of the better risk-adjusted returns out there, said Chris Kotowski, a bank analyst at Oppenheimer & Co. in New York. “Especially since rates on just about everything else are so shockingly low.”

As investors sought a haven from Europe’s debt crisis, yields fell this year to the lowest since the 1960s, a Bond Buyer index shows. Yields on tax-exempts due in 30 years have still exceeded those on Treasuries of a similar maturity by about 9 percent on average for the past two years, data compiled by Bloomberg show.

Regulatory Fuel

Increased regulatory scrutiny is also supporting banks’ move into munis.

Since the 2008 collapse of Lehman Brothers Holdings Inc., the Basel Committee on Banking Supervision has set guidelines to reduce banks’ risk. The measures, known as Basel III, will more than triple the core capital that lenders must hold to at least 7 percent of assets, weighted for risk.

“By regulatory standards they need a lot of something they can turn to cash very quickly without really a lot of losses,” said Paul Miller, a bank analyst at FBR Capital Markets Corp. in Arlington, Virginia. “Munis fit that category.”

Percentage-wise, New York-based JPMorgan added the most munis among the banks reviewed by Bloomberg.

The nation’s biggest bank by assets held $37.5 billion of munis as of June 30, up from $14.7 billion two years earlier, according to quarterly filings. Jennifer Zuccarelli, a spokeswoman, declined to comment.

‘Risk-Return’

Wells Fargo, based in San Francisco, increased state and local debt to about $40 billion from $18 billion in the period.

The bank has boosted munis “because we think we can get a good risk-return there,” Tim Sloan, chief financial officer at Wells, the fourth-largest U.S. bank, said at a Barclays Plc conference in New York on Sept. 11.

Pittsburgh-based PNC’s state and local debt also more than doubled in the period. Fred Solomon, a spokesman for the seventh-largest U.S. bank by deposits, declined to comment.

Some banks have bucked the trend. Bank of America cut tax- exempts by almost two-thirds, to $2.8 billion. Jerry Dubrowski, a spokesman for the Charlotte, North Carolina-based bank, declined to comment. Citigroup Inc. held $24.6 billion of munis, down 1 percent. Scott Helfman, a spokesman for the New York- based bank, declined to comment.

As most banks have expanded municipal holdings, deals have gone from having two or three times more orders than available bonds to sometimes as much as 20 times, said Hayes of BlackRock, the world’s biggest asset manager.

“As institutional investors, we certainly get access to more bonds, but nonetheless, in these new-issue markets, we’re competing and it’s harder to get bigger allocations” as the banks have become bigger buyers, he said.

In trading last week, the yield on 10-year AAA munis fell 0.06 percentage point to 1.72 percent. It dropped to 1.63 percent July 27, the lowest since at least January 2009, data compiled by Bloomberg show.

Following are pending sales:

PENNSYLVANIA ECONOMIC DEVELOPMENT FINANCING AUTHORITY plans to sell $2.9 billion of tax-exempt, unemployment compensation revenue bonds as soon as tomorrow, data compiled by Bloomberg show. (Added Oct. 1)

GUAM POWER AUTHORITY is set to sell $354 million of revenue bonds as soon as this week, data compiled by Bloomberg show. The sale will refund debt sold in 1993 and 1999 and will be enhanced with bond insurance, according to offering documents. (Added Oct. 1)

To contact the reporters on this story: Michelle Kaske in New York at mkaske@bloomberg.net; Michael J. Moore in New York at mmoore55@bloomberg.net

To contact the editors responsible for this story: Stephen Merelman at smerelman@bloomberg.net; David Scheer at dscheer@bloomberg.net


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