Philadelphia was running low on cash in August 2009 as Pennsylvania lawmakers refused to pass a temporary sales-tax increase for the state’s biggest city.
Unable to sell notes with the legislation in flux, the fifth-most populous U.S. city turned to JPMorgan Chase & Co. for a $275 million loan. The firm was rewarded two years later, when Philadelphia chose it over 13 other banks to manage a $254 million negotiated bond issue.
“JPMorgan brought their balance sheet to support the city,” said Nancy Winkler, Philadelphia’s treasurer. “That’s an important relationship, their ability to bring that.”
JPMorgan, which emerged from the worst financial crisis since the 1930s as the most profitable U.S. bank, has parlayed crisis-era loans to cities and states and a willingness to outbid other firms in local government bond auctions into becoming the top underwriter of municipal debt last year, according to data compiled by Bloomberg. It was the first time the firm held that rank.
The turnaround was a milestone for JPMorgan’s municipal-bond department, which has been marred by its involvement in two of the biggest scandals in the history of U.S. public finance: a so-called pay-to-play scheme in Jefferson County, Alabama, that contributed to the biggest-ever U.S. municipal bankruptcy, and a federal probe that uncovered bid rigging of municipal-bond investment products. It also underscores state and local officials’ willingness to overlook bankers’ past abuses when they set out to borrow money in debt markets.
“I haven’t found an investment bank that hasn’t had some problem in the last three years,” California Treasurer Bill Lockyer said in a telephone interview. “We do business with them all. I think they provide good service. I think they’ve been highly ethical with us.”
In November 2009, JPMorgan agreed to a $722 million settlement with the U.S. Securities and Exchange Commission to end a case over secret payments to friends of Jefferson County commissioners in the sale of sewer bonds and interest-rate swaps. The county filed for bankruptcy protection four months ago. Last July the firm agreed to pay $211 million in a separate settlement with state and federal regulators, admitting that former employees had rigged bids of municipal-investment contracts.
In 2011, JPMorgan managed $35.7 billion of long-term bond sales, $200 million more than Bank of America Merrill Lynch, its closest competitor, according to Bloomberg data. This year through March 19, JPMorgan also ranked first, with Bank of America second.
‘Deploying Our Capital’
“Deploying our capital for municipalities and non-profits all around the country is one of the most powerful ways we, as an institution, can use our position of strength,” said Paul Palmeri, 46, who was selected to head New York-based JPMorgan’s public-finance department on March 13.
The financial crisis that began in 2007 led to a consolidation of investment banking, including in the $3.7 trillion U.S. municipal market. Bear Stearns Cos., the broker-dealer operation of Lehman Brothers Holdings Inc. and Merrill Lynch & Co. were absorbed by JPMorgan, Barclays Plc and Bank of America Corp. respectively. UBS AG left the public finance business.
Last year JPMorgan, Bank of America Merrill, Citigroup Inc. and Morgan Stanley managed 46 percent of the $283.3 billion in long-term municipal debt issued in the U.S.
Issuance fell 36 percent from the previous year because the federal Build America Bonds program expired and cash-strapped governments curbed new borrowing.
Palmeri took over the bank’s municipal business from Jeff Bosland, who was promoted last week to the head of sales and marketing for fixed income and equities in the Americas.
Palmeri, a drummer who played in high school and college bands and counts Rush’s Neil Peart and rock-fusion percussionist Shane Gaalaas among his favorites, was formerly head of municipal sales and trading.
Bosland and Palmeri joined JPMorgan’s municipal department from other parts of the bank in April 2008. Bosland, who was JPMorgan’s head of agency trading and underwriting, became co-head of public finance. Palmeri, who worked in the bank’s mortgages group, became head of short-term municipal sales and trading.
Financial damage was all around them. A month before, JPMorgan had acquired Bear Stearns in a forced sale, after clients and investors pulled $17 billion in cash from the 85-year-old firm in two days, fearing losses on subprime bonds.
Meanwhile, the SEC was probing JPMorgan’s sales of $5 billion of bonds and derivatives to Jefferson County. And federal prosecutors were targeting the bank’s former head of municipal derivative sales and at least four others in a criminal antitrust investigation into bid rigging involving products that state and local governments use to invest bond proceeds.
‘Work to Do’
“It’s very fair to say, when we began in 2008, we had a lot of work to do,” said Palmeri.
One of their first priorities was integrating the JPMorgan and Bear Stearns banking teams. JPMorgan cut about 70 of its public finance employees, replacing some of them with Bear personnel. The acquisition boosted JPMorgan’s profile in state housing finance and helped it expand its national banking coverage. Key hires in transportation and public power brought in more clients.
The bank also started addressing its regulatory and legal issues.
In September 2008, JPMorgan said it would close its municipal derivatives desk, stopping the sales of interest-rate swaps to states and local governments.
A year later, the SEC sued two former JPMorgan bankers, saying they made more than $8 million in secret payments to friends of Jefferson County commissioners. The firm inflated the cost of the swaps to cover the payments, the SEC said.
Larry Langford, the former Jefferson County commissioner in charge of finance, was found guilty on U.S. criminal charges of accepting bribes from a local investment banker who had received payments from JPMorgan. No charges were filed against the firm.
Under chief executive Jamie Dimon, who joined the bank after the Jefferson County deals were done, JPMorgan largely avoided investing in subprime housing loans. Dimon has said the bank didn’t need $25 billion in bailout money offered by the Federal Reserve.
JPMorgan was the only major U.S. financial institution to remain profitable throughout the crisis. On March 13, it raised its dividend and authorized a share-repurchase plan after passing the Federal Reserve’s tests of how lenders would fare in an economic decline.
Continuing to Lend
The bank continued to lend to state and local governments throughout the recession as others pulled back, with the support of senior management.
“They walked into the financial crisis with one of the strongest bank balance sheets. Why not use it?” said Christopher “Kit” Taylor, former executive director of the Municipal Securities Rulemaking Board. “You probably knew you were going to get the underwriting on the other side.”
In August 2009, after California closed a $24 billion budget deficit, JPMorgan loaned the state $1.5 billion so it could pay IOU’s issued during a cash crisis. The loan helped keep the state funded until September, when it could issue $8.8 billion in short-term debt.
Last month, JPMorgan loaned California $500 million for four months at 0.2 percent so the most-populous U.S. state could pay bills after tax collections trailed budgeted amounts. Barclays, which acquired Lehman’s investment banking and capital markets operations, also lent the state $500 million, charging a lower interest-rate than other banks, Lockyer said.
JPMorgan and Barclays also co-managed a $1.9 billion refinancing for the state. Lockyer said that the favorable terms of the short-term loan “was one of the considerations” for hiring the two banks to handle the refinancing.
Lockyer said JPMorgan’s support in hard times is something officials remember when issuing new bonds.
“When there’s a stretch on the side of the bank and a good deal for the state, we certainly consider that when we’re doing future business,” he said. “It’s not automatic but it certainly gives them brownie points.”
In addition to offering direct loans, JPMorgan has increased its focus on competitive underwriting, showing a greater willingness to commit the bank’s capital to buy bonds and then resell them to investors. JPMorgan increased its share of competitive long-term bond issues last year to 19.5 percent from 10.3 percent the previous year, according to data compiled by Bloomberg.
In a competitive sale an issuer offers its bonds for sale and banks bid against each other to purchase the bonds. The bank assumes the risk it might not be able to sell all the bonds it bought.
Nationwide, about 20 percent of debt issued by states and local governments is sold through competitive bids. The rest is done through negotiated underwriting, in which municipalities select a bank in advance to price the bonds.
JPMorgan’s readiness to take risks in competitive underwriting was on display in December 2008, when, a week after Illinois Governor Rod Blagojevich was arrested, it was the only bank to bid on a $1 billion portion of $1.4 billion in short-term notes. The state had delayed the deal because of Blagojevich’s indictment for bribery.
JPMorgan also bought $9.1 billion of $9.8 billion of short-term notes auctioned by Texas last August -- the biggest competitive auction in municipal-market history.
‘Shows Our Commitment’
“That shows our commitment to use our balance sheet when we think it’s appropriate to help our clients,” Palmeri said.
This December, in a $400 million auction of Massachusetts bonds on December 20, JPMorgan offered a total interest cost of 2.57 percent, beating Bank of America, the second-lowest bidder, offering 2.79 percent. The competition helped Massachusetts save $880,000.
As part of the Massachusetts deal, JPMorgan agreed to buy $40 million of bonds maturing in 2021, paying $114 per $1,000 security. The same day, $10 million of the bonds were sold to a customer for $113 per $1,000 bonds, a $100,000 loss, trade records filed with the Municipal Securities Rulemaking Board show.
“It’s not a high-margin business, but it’s a business that’s incredibly important to our clients,” said James Lansing, JPMorgan’s head of municipal debt capital markets. “If a firm is willing to commit its own capital to underwrite bonds and it’s confident that it can distribute that paper, that’s a great fact that other issuers can point to and say, ‘I know I can award negotiated business to this underwriter because they’re going to get great execution.’ ”
That’s what happened in Washington State last year. The state chose JPMorgan from a pre-qualified pool of banks to manage $1.1 billion of bonds. The state selected JPMorgan in part because of the bank’s participation in its competitive bond sales and also its expertise in structuring transportation deals, said Chris McGann, a spokesman for Treasurer James McIntyre.
“They’re able to place the bonds and they’re familiar with the type of investors who like to invest in Washington,” McGann said.
JPMorgan has beefed up its distribution to individual investors through strategic agreements with UBS and Charles Schwab & Co. The agreements give JPMorgan access to 17,000 of the two firms’ retail brokers.
Beyond the Scandals
That JPMorgan was able get underwriting business in Philadelphia shows it has moved beyond the scandals.
In 2005, two former JPMorgan bankers pleaded guilty to arranging a $50,000 payment to a bond lawyer and fundraiser for former Mayor John Street to get underwriting business.
That prompted officials working for the new mayor, Michael Nutter, to avoid doing underwriting business through JPMorgan for more than year, Treasurer Nancy Winkler said.
That changed when JPMorgan loaned Philadelphia money to pay its bills in August 2009.
“They got rid of a lot of people, a lot of leadership, as well as the bankers,” she said. “The bankers that they have covering the city are very good. We need to be able to have them as partners.”