Market volatility impacts two BAB refunding deals

As the war with Iran rages on and oil prices rise, volatile market conditions impacted at least two Build America Bond refundings early in the week.

Both taxable deals ? from the Bay Area Toll Authority and the Dormitory Authority of the State of New York ? were held back because of volatility, which has created significant uncertainty amid a market selloff.

"Anytime there's uncertainty, you see the market react accordingly," said Kyle Gerberding, director of trading, a portfolio manager and partner at Asset Preservation Advisors.

Currently, the market is navigating volatility driven by geopolitical issues, which has led to some trouble for certain deals. Next week features a Federal Reserve meeting, which could be another catalyst for deals having trouble getting done, said Cooper Howard, a director of fixed income research and strategy at Charles Schwab (SCHW).

Along with the BATA and DASNY deals being impacted by market volatility, a tax-exempt portion of Chicago's $800 million was pulled, with pricing set for an unspecified date.

New York's Metropolitan Transportation Authority, which on Feb. 25 posted a notice about a potential BABs refunding, is holding off on the transaction for now. "There are currently no plans to refund Build America Bonds next week," an MTA spokesperson said. "We are monitoring the market for Build America Bonds to identify potential refunding opportunities."

"All eyes are on what's happening in the Middle East and how prolonged that's going to be," Howard said. "If it is going to be a short-term issue, it's likely that the market will continue to look past that and trade more off of global growth expectations for inflation and then also supply and demand. But if it does appear that it is going to be prolonged and concerns over the Strait of Hormuz, then that's likely translating into higher expectations for inflation and weakening growth."

This comes at a time when some strategists note there could be a resurgence of BAB refundings.

Just this week, the New York City Municipal Water Finance Authority posted a conditional extraordinary redemption provision, or ERP, call notice for one of its BAB securities, J.P. Morgan noted in Wednesday's report.

Since 2024, BAB ERP activity totals around $33 billion, according to the firm.

"In the current environment of higher interest rates and lower ratios, Build America Bond (BAB) refundings are re-emerging in the market," J.P. Morgan strategists wrote in a Jan. 29 report.

"We remain bullish on BABs, especially those with maturities in 2040, and continue to see little value in non-BAB taxable muni spreads; if anything, they can probably act as a good hedge for municipal portfolios at current levels," Barclays (BCS) strategists led by Mikhail Foux wrote in a Feb. 20 report.

Many BAB refundings were structured so that principal didn't start coming due until 2025 or 2026, noted Pat Luby, head of municipal strategy at CreditSights.

"So even though they've been paying interest, which a lot of it has been subsidized, the motivation to restructure has materialized in 2025 and 2026," he said. Combining it "in some other financing that you may have on the drawing board makes sense."

BATA was set to refund BABs in a deal slated for Monday, but market conditions forced the issuer to delay the deal, said its CFO Derek Hansel.

Several weeks ago, BATA "took out a good chunk" of BABs, opting to do the refundings in two pieces. The first piece, $283.39 million of San Francisco Bay Area Toll Bridge revenue bonds, came to market three weeks ago, along with a seven-year put bond, and the deal went very well, Hansel noted.

However, the conflict in the Middle East made it a little more challenging to refund its BABs early this week, leading the issuer to postpone the deal until later, when the economics make more sense, he said.

"We watched the market sell off on Tuesday. It looked like last Wednesday was a little more constructive. And then the market did kind of set, seemed to have solidified on Friday, which was good. We went into marketing Monday morning and it seemed like the tone might have been a bit softer.

"We went in eyes open, knowing, 'Hey, we're going to price at a level that works for us,'" Hansel said.

Part of the problem was some AAA scales hadn't caught up to munis cheapening on Monday, "so people are looking at those spreads, and they're saying, 'Yeah, we're not going bonds there.' For us, that's OK, because we weren't going to chase the market. There's no reason for us to do that. In this case, I don't need to refinance them. We're opportunistic on this. We'll take them when we can get them," he said.

Meanwhile, "DASNY printed the PIT POS with a size of $2.5 billion, which included new money and refunding as well as refunding of Build America Bonds," Brendan Kennedy, DASNY press officer, said in an email.

Based on Monday's market volatility, DASNY decided not to include the refunding of BABs at that time, and came to market with a $1.6 billion deal, he said.

However, based on strong retail and institutional demand on Monday and Tuesday, respectively, the authority upsized the deal by $448 million to include one series of BABs, bringing the total transaction size to $2.1 billion, Kennedy said.

"To get $1.6 billion or $2.1 billion in place ... where rates are moving higher by the day, what we're seeing [was DASNY] taking advantage of it while they could," Gerberding said. "Because, of course, the risk is if rates continue to move higher from here, and then they're just unable to ever go ahead and do that BAB refunding. So they were just really trying to take advantage of the demand while they could."

BABs became a topic du jour in 2024 following a favorable U.S. Supreme Court decision, leading issuers to flock to market to refund their Obama-era bonds.

"Everybody kind of rallied around to the conclusion that you can use this extraordinary call provision," said a lawyer who requested anonymity.

However, controversy arose again after investors threatened to file a lawsuit against the Regents of the University of California over whether issuers were legally authorized to trigger the extraordinary redemption provision following cuts to BABs' 35% subsidy under the government sequestration process, starting in 2013.

The controversy, though, has had minimal impact on issuers' decisions to move forward with BAB refundings.

"All of the issuers and investment bankers have kind of said, 'Okay, this is now available, and that controversy seems to have gone away," the lawyer said.

The source said several clients refunded BABs in situations where they didn't receive the expected savings.

"Their reason for doing that [at lesser savings] was because they're fearful about what the sequestration rates are going to be in the future," the source said.

There was a possibility near the end of 2025 that the sequestration rate would go to 100%, and while it didn't, it was a risk, the source said.

"There are issuers out there who are just like, 'Look, if we can get out of these things and have it not cost us anything or get some minimal savings, let's do it,'" the source said.

However, most issuers that still have BABs outstanding are thinking, "We'll refund them if it makes sense to refund them from a pure economic perspective," the source said.