Another large bank plans to exit the muni market

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Welcome back to Route Fifty’s Public Finance Update! I’m Liz Farmer and before I get into this week’s topic, I wanted to announce that this issue of the newsletter is my last. Since the launch of the Update in 2021, I’ve enjoyed bringing you the latest analysis on pensions, property tax reform, distressed cities and whatever else is on the agenda. Although I’m moving on to a new opportunity, I’m proud of what we started and happy to say this newsletter will carry on without me.

And now the news, which this week is all about how municipal bond stakeholders are reacting to Citigroup’s announcement that it’s exiting the business in 2024. According to a memo to staff seen by Bloomberg News, Chief Executive Officer Jane Fraser said that underwriting state and local debt was “no longer viable given our commitment to increase the firm’s overall returns.” 

Although Citi’s municipal bond division has shrunk in recent years through layoffs, retirements and other departures, the news that it’s shutting down still came as a surprise. As recently as 2021, Citi was the second-biggest underwriter, accounting for roughly 10% of all new securities sold.

The firm’s exit follows a similar decision by UBS, which announced it was pulling out of the muni business in October, and comes on the heels of several departures over the last few years of small investment banks from the market. 

The last few years in the municipal bond market have been volatile ones, and Citi’s exit could reflect that. But many believe that the recent bank boycotts by conservative politicians whose politics clash with some banks’ investment strategies played a role in Citi’s decision. 

In January, Texas Attorney General Ken Paxton banned Citi from working on muni deals in the state, after saying the bank discriminated against the firearms sector. Bloomberg reports that Texas is the biggest source of new municipal bonds, accounting for 16% of overall issuance in 2023.

“You can make a strong case that getting kicked out of Texas was a particularly painful thing for that firm to go through—which it would be for any large firm—but it just underscores the political risk that comes with being in this business,” said Justin Marlowe, director of the University of Chicago’s Center for Municipal Finance. “A lot of CEOs would look at that and say, ‘The juice is not worth the squeeze.’”

The Cost of Culture Wars

Over the past two years, more than a dozen Republican-led states have initiated bans or severely limited business with banks that promote anti-fossil fuel policies and adhere to environmental, social and governance, or ESG, standards.

“We're not going to pay for our own destruction,” West Virginia State Treasurer Riley Moore told FOX Business in a 2022 interview after he barred five banks for their ESG push. "We're not going to subsidize that. They have weaponized our tax dollars.”

But the assault on banks by some elected officials has others worried it could sour overall relations in a $4 trillion market that—for as big as it is—is all about relationships.

“If you're negotiating [a deal], you're going to have deep, entrenched relationships with a lot of banks, and for a large issuer, you're probably going to want to have all of the Wall Street banks on call,” said Emily Brock, director of the Federal Liaison Center at the Government Finance Officers Association. “Now UBS is out and now we have a second bank that's out—that's a significant limitation.”

Citi's exit from the market means one less competitor vying for underwriting business, which can affect the cost of issuance for everyone, said Washington State Treasurer Mike Pellicciotti. His office plans on conducting a review, at the request of the state legislature, of how anti-ESG efforts by other states might be impacting the larger national economy and ultimately, the state of Washington. 

"Those competitive offerings allow us to achieve very favorable bond rates here in the state of Washington, and often Citi has been a successful bidder," he said. "Their success shows that they bid in a way to actually participate in the market, and in a very significant way. That's one of the things we'll be looking at."

Muni Market Stability

There has been a lot of upheaval in the muni market over the last few years. The pandemic in 2020 temporarily upended the market, and while 2021 saw more stability, 2022 marked the worst year for munis since 1981.

However, Citi’s decision to leave comes as interest rates are stabilizing and market index prices are higher than they were in January, according to University of Chicago's Marlowe. 

“There's definitely been a strong upward movement in the last few weeks,” he said. “And if that continues—and there's good reason to think that will—we might be able to look at [Citi’s exit] as having more to do with the last months or years, rather than where the market is headed now.”

Brock of the Federal Liaison Center added that banks might perceive the influx of federal funding for infrastructure in recent years as an “aggravating factor” in the market’s turmoil. With more cash, there’s the potential for less borrowing. But in the long-term many see the federal government’s commitment to funding infrastructure needs as a strength for the market.

More immediately though, the exit of another big bank from munis—and the potential for higher borrowing costs—could serve as a warning signal. 

“There may be an opportunity,” Brock said, “for states to stop and say, ‘The more that we limit this, this isn't just [statement of] principle. This actually has a significant market effect.’”