Tender offers and BABs strategies panning out

Elevated interest rates combined with the inability to advance refund tax-exempt municipal bonds presents issuers with creative possibilities for dropping debt load by executing tender offers and off-loading Build America Bonds.

"As of October, Bloomberg data suggests that there are about $79 billion of BABs outstanding," said David Womack, the deputy director, of the New York City Office of Management and Budget.

"At a similar time about a year or so ago, there were about $116 billion, so a fair amount has been refunded."

The comments came during the Government Finance Officers Association's Mini Muni Conference on Wednesday.

BABs were created in 2009 to help pull the economy out of the Great Recession as taxable instruments eligible for a 35% direct-pay subsidy from the federal government.

Things went awry four years later when budget sequestration began cutting into the 35%.

"Since 2013 the 35% subsidy that issuers received has been reduced every year from 8.7% to the current 5.7%," said Womack. "Congress in the One Big, Beautiful Bill Act extended the sequestration through 2031."

Issuers looking to limit the size of their haircuts on BABs began exercising extraordinary optional redemption provisions known as ERPs, which allows them to call the bonds early and end the carnage.

Investors and the federal government disagreed, and the dispute went to trial.

"There is a court decision involving the Indiana Municipal Power Agency versus the U.S. that supported the conclusion that the sequestration cuts did result in an extraordinary event, and is effectively a material change to the code," said Womack.

Tax attorneys and bond counsel are employed to make sure the wording of Official Statements includes the proper ERP verbiage to permit issuers to bail out of BABs.

The strategy includes refunding BABs with tax-exempt bonds which can reduce debt service costs.

"If you introduce and refund with tax-exempt bonds, you'll get a 10-year par call back if you've got longer than 10 years left on your bonds," said Womack.

Getting BABs off the balance sheet can also reduce future sequestration risk and sidestep the possibility that Congress will stop authorizing the subsidy due to a violation of the Pay-As-You-Go provision.

Tender offers also present issuers a chance to cash in while interest rates are elevated.

"Even with the Fed's recent actions to lower rates again, we're still seeing refunding opportunities," said Nikolai Sklaroff, the capital finance director of the San Francisco Public Utilities Commission.

Sklaroff concedes that putting a successful tender offer together requires a combination of "art and science" that teeters on finding investors who want to sell their bonds for less than par value and offering them a price slightly higher than what they can get in the open market.

"In March, our commission authorized tender refunding together with other refundings identifying almost $1.9 billion of candidate bonds," said Sklaroff

"We had a very successful sale of $523 million and lowered our future ratepayer cost by $56.2 million. This lowered debt service just in time for the new money bonds that we were planning to issue two months later."

A successful refunding through a tender requires thorough market knowledge and carefully choreographed notices posted on EMMA.

"A well-crafted tender gives you multiple bites at the apple to give you help you find the right pricing level," said Sklaroff.

"It leaves you multiple opportunities to drop candidates if the pricing doesn't pencil anymore and meet your savings targets."