The Bond Buyer reported earlier this week that US Bank is downsizing its long term municipal bond underwriting and sales and trading. Bond underwriting, particularly in the hospital sector, has become increasingly dominated by a handful of Wall Street investment banks and tax reform could push more small firms to leave the business or sell to larger players.
In letting go of a large chunk of its municipal finance business, US Bank appears to follow in the footsteps of SunTrust Robinson Humphrey, who quietly got out of the long term tax exempt public bond underwriting business last year. Both firms remain active in bank placements, taxable debt, and short term municipal notes.
There are a number of factors causing investment banks to cut back on public finance:
- Fierce competition among major Wall Street firms
- Lower issuance volumes; volumes have rebounded some but have gone to the larger players
- Limited appetite for swaps; in their heyday, swaps provided up to 70% of public finance profits
- Retail demand is redirecting mark-ups away from sales and trading desks to fee-based retail financial advisors.
- Increased regulatory costs
- Shrinking underwriting fees and profitability; a result of all of the above, as well as low interest rates.
Smaller firms and marginal players with limited traction in public finance are most affected.
Scale is key to making money in municipal finance. This has led to the growing dominance of a few key players, particularly in the healthcare sector. In the last three years alone, the top five hospital underwriters grew their combined market share from 65% to 80%. To survive on their own, smaller firms must have some type of profitable niche business they can use to subsidize bond underwriting, typically wealth management or corporate finance.
Other recent casualties include William Blair and Cain Brothers.
After 50 years in municipal finance, William Blair exited public finance in mid-2017. Cain Brothers, once the most prominent healthcare investment bank on Wall Street, sold to Key Banc Capital Markets last year after losing much of its underwriting business to larger firms in the last few years. Guggenheim, Bank of Montreal, and Sterne Agee are among some of the other firms that exited the business in the last three years.
Other investment banks are bucking the trend and see an opportunity.
UBS, which got out of municipal underwriting in 2008, returned last year, betting on increased demand for tax exempt debt from high net worth clients.
There may be more bad news on the way for bond underwriters if tax reform reduces corporate investor demand for publicly-sold tax exempt debt, as some industry observers expect.