Key Takeaways
- Tender option bond (TOB) trust issuance was muted in Q1 2024, as fund-sponsored issuance declined due to elevated financing costs.
- Unrated housing issuance accounted for 60% of TOB trust issuance, with bank sponsors pursuing high-yield opportunities and expanding their low-income housing tax credit portfolios.
- Despite downgrades outpacing upgrades six to five, credit ratings across the TOB trust portfolio remain comfortably investment grade, with 78% above the 'A' category.
- Weekly volatility in the SIFMA Municipal Swap Index decreased significantly in March due to slowing remarketing.
- TOB trust average leverage jumped as funds took advantage of increased returns in the municipal bond market.
New TOB Trust Issuance Declined
In first-quarter 2024, TOB issuance by par amount was down 51% compared to Q1 2023 due to higher financing costs. The SIFMA Municipal Swap Index, upon which TOB floating-rate issuance prices are based, averaged 3.31% in Q1. This is below the 3.64% in Q4 2023, but it remains elevated from quarters prior to Q3 2023. Issuance spiked to approximately $700 million in mid-March, primarily driven by a large one-off trust.
Chart 1
Chart 2
SIFMA's weekly volatile streak continued throughout much of Q1. However, this began to change in February as the volume of unremarketed bonds--also called inventory--stabilized. Much of the SIFMA volatility can be attributed to rate changes following large inventory swings since the rates hikes started in 2022.
Average leverage across fund-sponsored TOB trusts rose to 3.3x in Q1 2024 from 2.3x in Q4 2023. This was partly due to positive municipal bond returns in December 2023 in anticipation of further rate cuts this year. For fund sponsors, leverage magnifies the impact of bonds returns. As municipal bond prices rose in December 2023, fund sponsors with greater leverage in their TOB portfolios benefited more. (For more information on how TOBs contribute to portfolio leverage, see "U.S. Fund-Sponsored Tender Option Bond Leverage Remains Elevated As Short-Term Losses Rise," published Jan. 26, 2024.)
Chart 3
Sponsor Trends: Banks Drove Issuance
Fund-sponsored TOB issuance by par fell dramatically quarter-on-quarter, as financing costs remained elevated. For example, over that period, the issuances of Nuveen and Invesco--two of the largest TOB sponsors--fell 80% and 88%, respectively.
Bank-sponsored TOB issuance mostly reflected a large one-off trust issuance of approximately $650 million in March. This was sponsored by Barclays Bank PLC with underlying bond issuer Aztec Real Estate Parent LLC.
Chart 4
Chart 5
Municipal Sector Trends: A Shift Toward Housing
In the first quarter, securitizations of unrated housing bonds by bank sponsors dominated issuance (60% of the total) as banks pursued attractive yields. These trusts are set up with a custodial arrangement, whereby a custodial receipt--evidencing ownership in the unrated bonds--is deposited in the TOB trust. The bank sponsor credit-enhances the custodial receipt. If the unrated bonds don't make scheduled payments, the bank will cover the shortfall.
Chart 6
Table 1
Top 10 underlying bond issuers: Q1 2024 | |||
---|---|---|---|
Underlying bond issuer | Par amount (Mil. $) | Number of trusts | Sector |
Aztec RE Parent LLC |
652.593 | 1 | Unrated housing |
Arizona Industrial Development Authority |
103 | 3 | Unrated housing |
Triborough Bridge & Tunnel Authority |
85.165 | 3 | Governments--tax secured |
California Municipal Finance Authority |
65 | 2 | Unrated housing |
Pennsylvania Housing Finance Agency |
64.31 | 1 | Housing |
Commonwealth of Massachusetts |
57.915 | 3 | Governments--tax secured |
Austin Housing Finance Corp. |
39 | 1 | Unrated housing |
Wisconsin Health & Education Facilities Authority |
35.815 | 3 | Not-for-profit health care |
Broward County |
33.55 | 1 | Governments--tax secured |
San Antonio Housing Trust Public Facility Corp. |
33 | 1 | Unrated housing |
Credit Quality Remained Very Strong Despite Downgrades
In Q1 2024, we took 11 rating actions on TOBs. All of these were driven by U.S. public finance rating actions. There were five upgrades and six downgrades among four sectors: transportation, higher education, public utilities, and not-for-profit health care.
Chart 7
The TOB trust portfolio continues to be supported by strongly performing assets in the 'A', 'AA', and 'AAA' rating categories. Only one TOB trust has a lower long-term rating, and it's just one notch lower at 'BBB+'. This is two notches from the 'BBB-' tender option termination event threshold, which--if triggered--would result in an immediate winddown of the trust and sale of the underlying bond.
Chart 8
Barclays, JPMorgan, and Morgan Stanley provide liquidity support to approximately 62% of the outstanding TOB trust floater receipts portfolio. For certain banks, we primarily rate fund-sponsored issuance that bank supports. For example, JPMorgan sponsors approximately $400 million in TOB trust issuance while providing liquidity support to $4.8 billion in TOB floaters. The mismatch is due to rating agencies having different ratings on these banks (see below).
Chart 9
The table below shows our ratings on all banks that provide support to TOB trust issuance. Our outlook on JPMorgan Bank N.A. is positive, indicating we could raise the long-term rating over the next two years (see "JPMorgan Chase Outlook Revised To Positive On Franchise Strength And Ability To Deliver Solid Results; Ratings Affirmed," April 1, 2024).
Table 2
TOB bank support provider ratings | |
---|---|
Liquidity provider | Rating as of May 10, 2024 |
Bank of America N.A. |
A+/Stable/A-1 |
Barclays Bank PLC |
A+/Stable/A-1 |
Citibank N.A. |
A+/Stable/A-1 |
Deutsche Bank AG |
A/Stable/A-1 |
JPMorgan Chase Bank N.A. |
A+/Positive/A-1 |
Mizuho Bank Ltd. |
A/Stable/A-1 |
Morgan Stanley Bank N.A. |
A+/Stable/A-1 |
Royal Bank of Canada |
AA-/Stable/A-1+ |
The Toronto-Dominion Bank |
AA-/Stable/A-1+ |
UBS AG |
A+/Stable/A-1 |
Wells Fargo Bank N.A. |
A+/Stable/A-1 |
Related Research
- JPMorgan Chase Outlook Revised To Positive On Franchise Strength And Ability To Deliver Solid Results; Ratings Affirmed, April 1, 2024
- U.S. Fund-Sponsored Tender Option Bond Leverage Remains Elevated As Short-Term Losses Rise, Jan. 26, 2024
This report does not constitute a rating action.
Primary Credit Analyst: | Joshua C Saunders, Chicago + 1 (312) 233 7059; joshua.saunders@spglobal.com |
Secondary Contact: | Liam Felter, Englewood +1 303 721 4178; liam.felter@spglobal.com |
Research Contributor: | Sophia Frohna, Chicago; sophia.frohna@spglobal.com |
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