(Bloomberg) -- Texas Attorney General Ken Paxton is sending shock waves through the state’s booming municipal-bond market, leaving borrowers and bankers alike on edge.

At least two banks, RBC Capital Markets and Wells Fargo & Co., were dropped from underwriting muni deals since Paxton said last week that he was probing the energy policies of a group of finance companies given commitments they’ve made to cut greenhouse gas emissions. 

The review by Paxton, a rising star in the state’s Republican Party, targets eight Wall Street bond underwriters, including JPMorgan Chase & Co., Morgan Stanley, RBC and Wells Fargo. The group has handled more than a quarter of the $51 billion of muni sales from Texas cities and localities in 2023, data compiled by Bloomberg show. Those banks are now at risk of losing business in the Lone Star State.

The borrowing wave, to pay for the infrastructure needs of a swelling population, has catapulted Texas past California atop the ranks of muni issuance this year, making it a lucrative target for Wall Street public-finance desks. The review comes roughly two years after Texas GOP-backed measures taking aim at financial companies for their energy and firearm policies turned the market on its head. 

Paxton’s office approves muni deals in the state. If it doesn’t green-light a transaction, the deal is effectively canceled and the municipality would have to restart the borrowing process. That threatens to drive up costs given the volatility of interest rates this year.

Some Texas borrowers are already taking steps to head off any complications. For example, Roanoke, a city near Dallas that sold $32 million of munis via auction this week, wouldn’t accept the bid of any entity subject to an unresolved or pending inquiry by the attorney general’s office, its bond documents show. 

“The Texas Attorney General has put a strain on municipalities here in Texas as it pertains to marketing notes and going out to the market,” said Vernon Lewis, treasury director in the controller’s office in the city of Houston. “They’re in active investigation, so they haven’t said, ‘no, you can’t use this bank’ yet, which is good news for us. But there’s no telling when that will happen, and in the meantime, we have priced very well.”

The latest probe from Paxton could keep more banks out of Texas’ muni market. That would risk pushing up borrowing costs for the state and its cities as fewer banks compete to win transactions, said Derrick Mitchell, a public-finance lawyer and partner at Holland & Knight in Houston. Banks and borrowers are in “limbo,” he added.

“Like any other market, if you have fewer bankers or banks to service our issuers you should suspect that it may cost our Texas issuers more to sell bonds,” Mitchell said. 


This fight isn’t new. In September 2021, two separate laws took effect: One restricted Texas governments from working with companies that “boycott” the fossil-fuels industry and the other barred work with companies that “discriminate” against firearms entities. 

Read more: Texas’ Wall Street Showdown Costing Cities Hundreds of Millions

If more banks are barred, that could affect cities in other ways as well. Many municipalities work with the banks under review as part of depository and letter of credit agreements, according to a person familiar with the matter.

The new review came as a surprise to many in the state’s public-finance industry who expressed frustration over the ongoing saga. Several banks had already submitted documents to Paxton’s office, stating they were in compliance with Texas’ laws. In August, for example, Paxton’s office ruled that Wells Fargo was in compliance with the firearms policy and could underwrite deals. Banks also maintain that they do not boycott the fossil fuels industry. 

But Paxton’s letter announcing the review on Oct. 17 was “a warning shot that he’s still focused on enforcing his anti-ESG agenda,” said Erik Walsh, a lawyer with Arnold & Porter in New York who works with financial institutions. 

Paxton was temporarily suspended earlier this year and went on trial for impeachment charges. He was later reinstated as attorney general and cleared of all charges. 

Muni Fallout 

In light of the latest review, RBC was dropped from leading a deal by Del Rio, a border city along the Rio Grande, according to a person familiar with the matter. BOK Financial replaced the bank as the senior manager, the person said. Spokespeople for BOK, Paxton and Del Rio didn’t reply to messages seeking comment.

“We have a standing letter on file with the AG that certifies our compliance with” the 2021 energy law, an RBC spokesperson said in an emailed statement. “The AG can continue to rely on the letter.”

Separately, Wells Fargo was replaced with Raymond James on a $250 million bond deal for Cypress-Fairbanks Independent School District, outside of Houston. The school district declined to comment.  

Roanoke, for its part, awarded its bond sale to other banks that weren’t named as part of Paxton’s review. The financial adviser for the city declined to comment further.

©2023 Bloomberg L.P.