Citi’s Public Finance Exit Is Warning for Municipal Banking Industry

Yahoo Finance
Amanda Albright and Tanaz Meghjani
Wednesday, December 20, 2023 at 12:10 PM EST

(Bloomberg) -- Municipal bonds, often marketed by US banks as a do-good line of business, are taking a hit as Wall Street looks to cut costs.

Last week, Citigroup Inc. announced it would shutter its powerhouse municipal-bond department, marking the biggest departure of an underwriter since at least the 2008 financial crisis. The firm’s exit came after years of pressures that had already forced out some small shops.

Higher interest rates are largely to blame. US banks are struggling with a massive slowdown in investment banking revenue after a boom in 2021. They have been in cost-cutting mode, and public finance departments at the likes of Morgan Stanley have seen layoffs and turnover as a result. Meanwhile, dealmaking has also slowed within the muni market compared to the period before interest-rate hikes began. UBS Group AG even announced in October it would exit a key part of the muni banking business.

While small shops have long been a dying breed, the pullback by large Wall Street banks is one of the biggest blows to the muni-bond industry. Dealmaking has slumped in the era of higher interest rates. Increasingly fraught dealings with politicians from Texas — the No. 1 market for muni sales this year — and other GOP states over banks’ policies on guns and fossil fuels present another obstacle.

Read more: Citi Shuts Down Muni Business That Once Was Envy of Rivals

The $4 trillion muni marketplace is likely to continue to see underwriters depart as firms sell themselves to rivals or exit the business entirely. Just 87 firms are credited as managers of municipal-bond transactions this year, down 41% from a decade ago, according to data compiled by Bloomberg. Meanwhile, rival firms are seizing on the contraction and are already seeing major boosts to their business. That could give them an advantage in 2024 as interest rates are expected to continue to drop, creating a better dealmaking environment.

Fewer underwriters competing to win transactions could ultimately translate to higher borrowing costs for US municipalities as they replace aging roads, finance new schools and expand public transit.

“It’s hard to see any situation where fewer underwriters is good,” said Justin Marlowe, a professor at the University of Chicago’s Harris School of Public Policy. He said it could mean banks have smaller sales forces to pitch investors on transactions, resulting in less demand for deals and higher prices for municipalities. On the trading side, those big banks also play an important role providing liquidity to investors. They often can step in and buy when prices are dislocated.

The space has been shrinking for some time: The number of registered broker-dealers with the MSRB has dropped for at least five straight years. Lower fees present a major challenge, and they dropped again in 2023 to an average of $4.92 for every $1,000 of bonds sold, compared to $5.11 the year before.

Some firms have bought other shops because of competitive pressures. L.J. Hart & Co., an underwriting firm that specializes in working with Missouri school districts, sold to Commerce Bank earlier this year, but it still underwrites deals using the company’s name.

In 2022, Boenning & Scattergood’s municipal bankers and traders joined Stifel Financial Corp. The firm, which specialized in working with Pennsylvania municipalities, no longer has a muni bond department. Representatives there did not respond to requests for comment.

UBS decided to exit the industry after re-entering about five years ago, hiring dozens of bankers as part of that effort. While it will no longer underwrite bonds sold via negotiated sales — which account for the vast majority of new debt deals – the bank will continue to trade municipals and buy deals via auction.

Smaller Firm Advantage

Not all large banks are in retrenchment mode. RBC Capital Markets and Jefferies Financial Group have both boosted their market shares considerably. Stifel and Raymond James Financial, both smaller-sized banks ranked within the top 10 of underwriting firms, could also benefit if more banks depart.

“It’s a lean year for sure, and firms are struggling with the challenge of low volume — but this kind of environment presents more of an opportunity for middle market firms than for bulge brackets,” said Michael Decker, senior vice president for research and public policy at Bond Dealers of America, a trade group representing dozens of firms. Some companies may look to hire talent that’s exited big Wall Street shops, he said.

Edmond Hurst, head of capital markets and public finance at Carty & Co. in Little Rock, Arkansas, said the consolidation creates openings for him. “That gives us an opportunity for our niche to step in and fill those gaps,” he said.

Matt Fabian, a partner at Municipal Market Analytics, an independent market research firm, said it’s an inopportune time for big banks to leave the space because he expects a large pipeline of supply in the next five to 10 years.

Municipalities will need to tap the market to finance infrastructure for climate change adaptation and to upgrade aging structures, he said. Federal pandemic aid is running out, which could also spur new sales. Some analysts are expecting a better issuance environment as early as next year.

“It’s bad timing for the firms to leave because they’re losing out on what should be a very profitable decade ahead,” Fabian said. “But also, for the country at large, we’ll have to pay more for its infrastructure if they do leave.”

--With assistance from Joe Mysak and Josyana Joshua.