Key Takeaways
- In second-quarter 2024, tender option bond issuance rose 21% to $1.8 billion due to increased fund-sponsored activity, though it declined year over year.
- Citibank sponsored $148 million in new issuance under its new 3a-7 compliant program in June, which is expected to ramp up in the second half of the year.
- Unrated bonds, specifically in the affordable housing sector, continued to represent most securitizations (54%) as sponsors seek higher yields.
- We raised 21 ratings and lowered four, primarily in the public transportation and not-for-profit health care sectors, which improved the upgrade to downgrade ratio to 2.6x.
- Average leverage as measured by floaters to residuals across fund-sponsored transactions remained steady at 3.32x.
Tender option bond (TOB) issuance increased 21% to $1.8 billion in second-quarter 2024 from $1.5 billion in the first quarter, driven by an uptick in activity from larger fund sponsors. However, total first-half issuance fell 37.5% year over year to $2.4 billion, compared with $6.4 billion in 2023 (see chart 1). S&P Global Ratings expects issuance to remain muted in the second half of the year due to elevated interest rates, raising TOB leverage financing costs, especially for fund sponsors (see chart 1). We also expect the cost effectiveness of short-term tax-exempt rates relative to short-term taxable rates to continue to drive a steady stream of bank sponsor activity. Historically, tax-exempt rates have remained at approximately 65%-70% of equivalent taxable rates. We also expect elevated financing costs to pressures issuance in 2024 (see chart 2 for a comparison of the SIFMA Municipal Swap Index, which interest rate of floaters reset from, the secured overnight financing rate, and the effective federal funds rate).
Chart 1
Chart 2
Sponsor Trends: Bank Sponsors Drive Fund-Sponsored Issuance
Banks continue to utilize TOBs as a tax-exempt financing tool for municipal bonds, and we expect this trend to continue in the second half of 2024 as interest rates remain elevated. The $1 billion bank-sponsored TOBs issued in the second quarter represented over half (55%) of total TOB issuance, despite declining from 64% in the first quarter.
Citibank N.A. issued four new transactions totaling $148 million under its new 3a-7 compliant program in June. Under this program, Citibank may securitize rated and unrated bonds, with Morgan Stanley acting as a remarketing agent. For more details on the program, see "Summary: FMSbonds Inc. (Series 2024-CF7001); Residual Certificates; Tender Option Certificates/Bonds," published June 6, 2024.
Although fund-sponsored leverage remains unchanged in second-quarter 2024 (see chart 3), fund-sponsored second-quarter issuance rose 50.9% quarter over quarter to $839 million, compared with $556 million in the first quarter, primarily driven by larger fund sponsors such as Nuveen LLC and Invesco Ltd. (see chart 4). In the second quarter, public and private fund-sponsored issuances totaled $647 million and $192 million, respectively. Nuveen's High Yield Bond Fund and Quality Municipal Income Fund remained its most active funds in the sector. Meanwhile, two Invesco closed-end funds, Value Municipal Income Trust and Quality Municipal Income Trust, have been more active this year, sponsoring nine of the 14 trusts Invesco has issued so far this year.
Chart 3
Chart 4
Chart 5 provides a breakdown of outstanding par amounts.
Chart 5
Sector Trends: Unrated Bonds Continue To Dominate As Spread Opportunities Remain Limited
Unrated municipal bond securitizations represented 54% of total TOB issuance, primarily in the multifamily sector, in the second quarter. This was down from 62% in the prior quarter as banks and funds both seek higher yields in the sector (see chart 6). It also represented a dramatic shift away from investment-grade sectors (rated 'BBB-' and above): tax-secured TOBs comprised only 13.5% of total issuance in the second quarter; and none were backed by not-for-profit health care. The trend toward unrated bonds in TOBs is mirrored in the broader market as investors look to capitalize on attractive yields in the municipal market.
Trusts holding unrated bonds require credit enhancement from a bank to be rated. However, these trusts are unique. They differ from the typical credit enhanced trusts holding rated bonds that benefit from joint support between two rated entities: the underlying bond obligor and the credit enhancer. In the more typical TOB structure, the likelihood of a tender option termination event (TOTE), which results in the immediate termination of the floater holder's put option and liquidation of the underlying bonds, is contingent on both rated entities triggering the event. When the trust holds an unrated bond where S&P Global Ratings hasn't opined on the credit worthiness of the obligor, the TOTEs are often revised to tie only to the credit enhancer.
The sponsors that have securitized unrated bonds in TOB trusts are primarily banks, followed by private funds and, rarely, public funds. One reason is because TOBs remain a costly means of financing for funds, while banks can utilize the product to tap into tax-exempt financing. For funds, unrated bonds require credit enhancement, which raises costs further.
We expect these trends to continue into the second half of 2024 as sponsors continue to look for spread opportunities between long-date municipal bonds and short-term TOB floaters (see chart 7 for a breakdown of the rated TOBs by sector.
Chart 6
Chart 7
In the second quarter, we raised 21 ratings and lowered four, which improved the upgrade to downgrade ratio to 2.6x (see chart 8). These rating actions were largely driven by rating actions in the not-for-profit health care and public transportation sectors. The affected ratings remained investment grade, with 'A+' being the lowest rating.
Still, the rating trends in the underlying not-for-profit health care sector remain cloudier. As of March, 23% of stand-alone hospital and 20% of health care systems had negative rating outlooks (see "U.S. Not-For-Profit Health Care Outstanding Ratings And Outlooks As of March 31, 2024," published April 19, 2024. In May, we made two upgrades and three downgrades, and revised six outlooks favorably and seven unfavorably (see "U.S. Not-For-Profit Health Care Rating Actions, May 2024," published June 21, 2024).
Chart 8
The short-term ratings on floaters remain almost exclusively 'A-1' or 'A-1+', with only $35 million floaters rated 'A-2' (see chart 9). Approximately 8% (51 trusts) of 'A-1'-rated floaters have a 'A' long-term rating. For trusts with a 'BBB-' investment-grade TOTE, we constrain the short-term rating to the lower of the short-term rating on the liquidity provider and the short-term equivalent of our rating on the underlying security, whether a municipal bond or credit-enhanced custodial receipt. For trusts without credit enhancement, we may lower the rating to 'A-2' if we lower the long-term rating.
Chart 9
Chart 10 provides a breakdown of the rated floater portfolio by liquidity provider.
Chart 10
Related Research
- Summary: FMSbonds Inc. (Series 2024-CF7001); Residual Certificates; Tender Option Certificates/Bonds, June 6, 2024
- U.S. Not-For-Profit Health Care Rating Actions, May 2024, May 2024, June 21, 2024
- U.S. Not-For-Profit Health Care Outstanding Ratings And Outlooks As of March 31, 2024, April 19, 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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