JPMorgan Chase led U.S. banks increasing direct loans to states and local governments last quarter as the firms filled a void left by mutual fund investors who fled the traditional municipal bond market amid soaring inflation and surging yields.
Banks lent a net $9.2 billion to states and cities in the three months through June, a 4.7% increase from the prior quarter, according to Municipal Market Analytics. It was the highest quarterly growth in about a decade and even eclipsed the tally from early 2020, a period of record volatility spurred by the pandemic, MMA said. Bank loans are another way for states and cities to raise cash if there's turmoil in the public markets.
"The increase in yields, the pullback from mutual funds, it changed the context and created an opening for banks," said Matt Fabian, partner at MMA, a research firm. "You have this demonstrated demand from banks to take muni supply out of the market if the market gets the willies."
Plummeting demand for municipal bonds from individual investors — a key buyer base — roiled the market for public offerings this year. The highest inflation in four decades and the Federal Reserve's campaign of aggressive interest rate hikes sparked a roughly
As a result, yields on benchmark 30-year munis rose to 3.37% in June, the highest since 2018, and borrowers postponed or shelved public offerings of municipal bonds. New issues fell 12.6% in the second quarter, according to data compiled by Bloomberg.
Bank holdings of municipal loans total a record $204 billion, MMA said, about 5% of the $4 trillion muni-bond market.
In the second quarter, JPMorgan Chase led direct lending with about $2.8 billion, according to MMA. Truist Financial and Bank of America followed with $1.6 billion and $1.2 billion, respectively.
Gurpreet Kaur, a spokeswoman for JPMorgan, said no one was available to comment. The bank is also the second-biggest underwriter of municipal bonds this year, data compiled by Bloomberg show.
Bank loans typically mature in three to five years, much shorter than the traditional 30-year maturity of bonds. The lower duration makes them less sensitive to price swings and losses if interest rates rise because of inflation. And with bank deposit rates
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 for specific projects and repayment periods, according to the Government Finance Officers Association, which represents public finance officials in the U.S. and Canada.
The increase in municipal loans could exacerbate a scarcity of new bonds, Fabian wrote in a note this month. States and localities flush with federal stimulus cash and rising tax revenue don't need to borrow as much.
"Banks' ability and willingness to take supply away from an unfavorable capital market should be seen as a warning to investors considering waiting for tax-exempts to get cheaper in the future," Fabian wrote.
