(Bloomberg) – JPMorgan Chase & Co. led U.S. banks to increase direct lending to state and local governments last quarter as companies filled a void left by mutual fund investors who fled the traditional market municipal bonds in an environment of soaring inflation and soaring yields.
Banks lent $9.2 billion net to states and cities in the three months ending June, a 4.7% increase from the previous quarter, according to Municipal Market Analytics. It was the highest quarterly growth in about a decade and even eclipsed the tally from the start of 2020, a period of record volatility spurred by the pandemic, MMA said. Bank loans are another way for states and cities to raise funds during turmoil in public markets.
“The rise in yields, the decline in mutual funds, it changed the landscape and created an opening for banks,” said Matt Fabian, partner at MMA, a research firm. “You have this demonstrated demand from banks to take the ammunition supply out of the market if the market has the nerves.”
Falling demand for municipal bonds from retail investors – a key buyer base – has rattled the public offering market this year. The highest inflation in four decades and the Federal Reserve’s campaign of aggressive interest rate hikes sparked an outflow of about $60 billion from municipal mutual funds in the last quarter, according to the Investment Company. Institute.
As a result, yields on benchmark 30-year munis hit 3.37% in June, the highest since 2018, and borrowers postponed or suspended public offerings of municipal bonds. New issuance fell 12.6% in the second quarter, according to data compiled by Bloomberg.
Banks’ holdings of municipal loans total a record $204 billion, MMA said, or about 5% of the $4 trillion municipal bond market.
In the second quarter, JPMorgan Chase led direct lending with about $2.8 billion, according to MMA. True Financial Corp. and Bank of America Corp. followed with $1.6 billion and $1.2 billion, respectively.
Gurpreet Kaur, a spokesman for JPMorgan, said no one was available for comment. The bank is also the second largest underwriter of municipal bonds this year, according to data compiled by Bloomberg.
Bank loans typically mature in three to five years, much shorter than the traditional 30-year bond maturity. The shorter duration makes them less susceptible to price fluctuations and losses if interest rates rise due to inflation. And with bank deposit rates close to zero, the loans offer “tremendous carry,” Fabian said.
Bank loans and direct placements have become popular because they can be quicker to execute and cheaper than public sales. Loans can also be tailored to specific projects and repayment periods, according to the Government Finance Officers Association, which represents government finance officials in the United States and Canada.
Increased municipal lending could exacerbate the shortage of new bonds, Fabian wrote in a note this month. States and localities with federal stimulus cash and rising tax revenues don’t need to borrow as much.
“The banks’ ability and willingness to withdraw supply from an unfavorable capital market should be taken as a warning to investors who are considering waiting for tax exemptions to become cheaper in the future,” Fabian wrote.
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