With tax-exempt advanced refundings gone, tenders step up


Issuers have had to become creative to derive interest cost savings in the years since the Tax Cuts and Jobs Act of 2017 eliminated the tax-exempt advanced refunding option.

A clear successor has yet to emerge, but rising interest rates, falling prices and fluctuating relative value prompted issuers to consider tender offers as a way to refinance their debt.

“It’s all about enticing the investors, the right premium to create the participation in order to do a viable deal where you create savings and lower debt service,” said James Pruskowski, chief investment officer and head of business development at 16Rock Asset Management.

Tenders allow issuers to restructure debt with new tax-exempt debt or tender-eligible taxable debt that can be “flipped back” to tax-exempt debt, he said.

For the latter, examples of eligible taxable debt include bonds issued to advance refund tax-exempts after the TCJA as well as outstanding taxable Build America Bonds, he noted.

“Tenders, for the most part, help to show how versatile the issuer community is, and they have shown themselves to be a very viable option versus both advanced refundings or in the cases where you’d have to wait for a current refunding to become possible,” said Matthew Gastall, head of Wealth Management Municipal Research at Morgan Stanley. 

Tenders, he said, “let the investors decide.”

Issuers can reduce their cost of capital by offering the tender and issuing new debt. The option also allows the investor to decide whether they want to hold onto their existing securities or participate in the new deal, Gastall continued.

If successful, this allows issuers to lock in current rates, he said.

From that perspective, Gastall said, investors can “avoid reinvestment risk if interest rates decline up into the point where the outstanding securities are either called or redeemed in final maturity and also to avoid any future open market uncertainties if they so choose.”

The municipal tender offer trend took hold in 2020 and volume rose above $4 billion in both 2021 and 2022, according to a Municipal Market Analytics’ report from earlier this year. About $14.1 billion has been tendered or invited to tender so far this year, according to Bloomberg data. Of that, $9.3 billion was taxable and $4.8 billion was tax-exempt.

This uptick in tender activity shows how rapidly tenders have become integrated into the muni market, said Matt Fabian, a partner at MMA.

Due to Chicago’s large transaction from earlier this year, 2023 “is on track to be the largest year for voluntary, non-distressed tender offers so far,” the MMA report noted.

James Pruskowski, Chief Investment officer, 16Rock Asset Management

The uptick in tenders suggests taxable issuance will be low for a very long time because “if issuers can easily tender the tax-exempt bonds for new tax-exempt bonds, it means that they won’t have to resort to a taxable advanced refunding,” Fabian noted.

This is a “very favorable trend” for the industry as a whole, he added.

New York City, which offered a tender on its taxable fiscal 2021 bonds at the end of May, joined other recent issuers opting to tender their bonds instead of engaging in a taxable refundings. The tender offering provided an “interesting opportunity” to get some value from taxable bonds issued to advance refund tax-exempt bonds, said Jay Olson, New York City’s deputy comptroller for public finance.

“The value there was that once the related escrows were paying down, those bonds were eligible to be reauthorized as tax-exempt bonds,” he said. “So we got some value from converting those bonds effectively from a taxable interest rate to a tax-exempt interest rate.”

New York City “received nearly 1,200 offers from bondholders during the tender process for a total of roughly $454 million, or 40% of the outstanding principal of the relevant bonds,” according to a press release. This was one of the city’s most successful tender offerings to date in the muni market.

The city will buy around 78% of the total amount offered for the tender, or $353 million. The tender process generated around $26 million of debt service savings, or 24% of total savings, the release said.

Olson said a tender was the most economical way to “bring in those bonds.”

New York City was “able to purchase the bonds in the market from the folks who put in their tender offer at dollar prices” significantly below the make-whole call floor price,” said Tim Martin, assistant controller for public finance at the New York City Office of the Comptroller.

“That’s where those savings was really generated,” he noted. “The combination of low purchase price, and then also flipping from a taxable rate to a tax-exempt rate.”

Refunding alternatives to tender offerings exist, though none are as popular and widely used nowadays.

Following TCJA, issuers turned to taxable advance refundings because interest rates were so low.

This allowed some of the larger and well-known issuers “to access the taxable market and get clean execution because they had adequate size and high quality,” said Ann Ferentino, a portfolio manager at Federated Hermes.

When rates were low, issuers could achieve interest rate savings by advance refunding tax-exempt debt with taxable munis, said Robert Miller, a senior portfolio manager for the Municipal Fixed Income team at Allspring Global Investments noted. “But as rates bounced up, that’s no longer the case.”

In this rising-rate environment, advanced refundings no longer make sense, market participants noted. It’s also in part why volume levels have plummeted over the past two years as issuers pulled back on taxables and refundings after record issuance in 2020 and 2021.

“We saw some alternatives in terms of like issuers doing exchanges on their bonds, we’ve seen some bring forward-delivery bonds … but I don’t know how successful those have been,” Ferentino said of options outside of taxable advanced refundings.

“Consideration of less conventional call periods, perhaps at a shorter duration, came into the conversation soon after enactment of the [Tax Cuts and Jobs Act], yet we have not seen much traction,” said Jeff Lipton, managing director of credit research at Oppenheimer Inc. “Furthermore, we have not seen higher variable-rate debt lately as a way to hedge against interest rate exposure.”

There has been a “higher utilization of forward-delivery bonds, with a future issuance date within the 90-day window prior to redemption, thus qualifying for current refunding purposes,” according to Lipton.

However, Pruskowski noted these bonds remain less popular for investors given heavy demand in the muni market on current income and risks to deliver in the future.

For all the benefits, Pruskowski said, “only the most sophisticated issuers have been focused on this because it requires a certain legal framework to abide by the rules, you have to have good banking relationships to entice the right premium and have good market timing, and the flexibility to get it done.”

This helps explain why tenders — despite being on track to hit record highs this year — are seeing mixed interest, Miller said.

“Some people will take the tender, other people will not, so part of bonds will still be left out there when all is said and done,” he said. “The interest in tenders is more on the part of the bankers and the insurers.”

“What they’re trying to do is set the tender price at a level that incentivizes buyers to let go of the bonds that they have in their portfolio,” Miller noted.

“You’re tendering [bonds] prior to the call date and so it puts more of the power in the buyers’ hands to a certain extent, because you have the option to either retain your bonds and do nothing,” Miller said. If the investor tenders the bonds, the issuer offers a price a premium to incentivize buyers to partake.

With this benefit, among others, Pruskowsi believes there will be a rise in tenders as “taxable rates stay high and tax-exempt rates stay low, and the elimination of advanced refunding options stays in place,” with tenders following a similar cycle as Build America Bonds.

“It’s post-COVID issued taxable bonds, it’s BABs issuance, it’s where escrows have expired,” he said. “It’s the advantage an issuer gets by picking up the economic windfall feature of the tax-exempt bonds, not only just the debt interest savings. And then from the buyer’s perspective, it’s the fact that you’re not only tax-loss harvesting, but you’re beating a benchmark because you’re getting premiums above prevailing market prices.”

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