The muni loan market emerges

By Felix Salmon
February 16, 2011
worrying about munis last week, I said that "the amounts here are far too big for states to go to the loan market instead: if investors won’t buy bonds, banks won’t lend the states the money they need".

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When I was worrying about munis last week, I said that “the amounts here are far too big for states to go to the loan market instead: if investors won’t buy bonds, banks won’t lend the states the money they need.”

Which might be narrowly true, when it comes to state borrowers in particular. But other borrowers are finding the banks quite eager to lend to them:

J.P. Morgan Chase & Co. is devoting billions of dollars to direct loans this year to both refinance deals and for new projects, according to a bank official. Last year, the bank made a few hundred million dollars of direct loans to municipalities. Now, the bank would consider making a single loan for hundreds of millions of dollars, the official said. It also is dispatching teams to explain the concept to wary public borrowers.

Citibank also is courting municipal borrowers with direct loans, according to several bond issuers. A spokesman for the Citigroup Inc. unit declined to comment.

“This used to be unheard of,” says Eric Friedland, managing director of public finance at Fitch Ratings…

For banks, this is a potentially lucrative business at a time when they are sitting on cash that isn’t earning huge interest and are reluctant to make loans for mortgages and other areas they see as risky…

When word got out that Riverside, Calif., was floating a bond recently, several bankers called offering direct loans.

This is a welcome development, I think. It brings a whole new investor class to the muni market, as well as a lot more serious underwriting in an area where the amount of diligent credit analysis has always been much lower than it should be given the size of the market.

That said, if banks start picking off the most attractive borrowers in the muni market, that might only serve to reduce the overall quality of outstanding municipal bonds. Every time a municipality issues a bond from now on, potential investors will start asking themselves whether they’re being offered the sloppy seconds which various banks have all passed on. Direct loans might be very attractive, on a case-by-case basis, to both borrowers and lenders. But if people continue to look for reasons to mistrust the municipal bond markets, this isn’t going to help.

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