(Bloomberg News) Sarah Bush Lincoln Health Center was set to borrow about $45 million for emergency-room and laboratory improvements in Mattoon, Illinois, when demand for tax-exempt debt began to dissolve late last year.
Investors, spooked by bank analyst Meredith Whitney's prediction of "hundreds of billions of dollars" of municipal defaults in 2011, started fleeing the market in record numbers, sending interest rates soaring, according to Craig Sheagren, the hospital's chief financial officer. As bond buyers ran, JPMorgan Chase & Co. and other underwriters stepped up with offers of loans, letting the institution bypass the public markets.
"I have not seen a better deal yet than what we got," Sheagren said recently of the 3.6 percent annual cost, almost half the market rate, that the hospital received on 15-year debt in March from JPMorgan in New York. At about the same time, Jamie Dimon, the bank's chief executive officer, was publicly cautioning investors on the risks of municipal debt.
Refuting Whitney's forecast, which helped send borrowing costs to two-year highs in January, the $3.7 trillion municipal-bond market rebounded this year, generating an average total return of 10 percent through Dec. 12, better than U.S. Treasuries and corporate bonds, Bank of America Merrill Lynch indexes show. Munis also trounced equities as the Standard & Poor's 500 Index lost 0.6 percent in the same period.
Jefferson County Bankruptcy
Even after Alabama's Jefferson County became the biggest government bankruptcy in the nation's history and some defaults surged, the annual average 10-year borrowing cost for top-rated states and local governments dropped to 2.37 percent Dec. 12 and remained there yesterday, according to a Municipal Market Advisors index. That was the lowest rate since the company began collecting the data in 2001.
The Federal Reserve helped fuel the bond-market rally by buying Treasuries. Banks that were flush with cash from record deposits added to surging tax-exempt returns. While reluctant to lend to companies and consumers amid the weakest economic recovery since early 2007, the institutions increased investments in municipal securities by 20 percent to $272.8 billion in the 12 months through September even as mutual funds and insurers cut holdings, the most recent Fed data show.
"The bank portfolios are dominating the marketplace," said Tom Doe, CEO of Municipal Market Advisors, an independent researcher in Concord, Massachusetts. "They are taking the bonds you want and establishing the levels at which you buy."
Diverting Debt Supply
Wall Street also bolstered the market because private placements and municipal loans diverted billions of dollars of supply, according to Bill Montrone, S&P's head of public-finance ratings. New bond offerings plunged this year, with about $248.5 billion of public sales through Dec. 9, down 37 percent from almost $394.7 billion in a similar period last year, according to data compiled by Bloomberg.
JPMorgan, the largest U.S. bank by assets, was among the biggest municipal lenders, according to data compiled by Bloomberg News. Yet Dimon, 55, publicly urged would-be buyers of state and local debt to use extra care in the months after Whitney made her default comments on CBS Corp.'s Dec. 19 "60 Minutes" broadcast. In March, Dimon said he anticipated 100 municipal bankruptcies.
"You're going to see some municipalities not make it," the banker said March 30 in Washington at a U.S. Chamber of Commerce event, echoing comments he made in January, when he noted that there are 14,000 U.S. municipalities. "I don't think it's going to shatter America, I just think it's a part of the credit cycle."