Issuance Remained Muted Despite Glimmers In Quarter Four
We believe 2025 tender option bond (TOB) trust issuance will surpass 2024 as short-term interest rates decline and spread opportunities for fund sponsors arise. TOB trust issuance totaled approximately $7.0 billion in 2024 compared to $11.4 billion 2023, when refinancing activity surged (see chart 1). Elevated short-term interest rates reduced spread opportunities for fund sponsors, driving down activity among third-party trusts. Bank-sponsored issuance remained strong in the first half of the year, primarily driven by two large trusts established under Barclays' program in March and June.
TOB trusts offer bank sponsors short-term tax-exempt financing opportunities, which become more attractive in an elevated interest rate environment compared to taxable equivalent financing. Issuance in the fourth quarter rose slightly compared to the earlier quarters, particularly among fund sponsors, following three rate cuts by the Federal Reserve on September 18, November 7, and December 18 (see chart 2). As of Jan. 27, 2025, we have rated $541.84 million of issued certificates compared to $350.0 million in January 2024.
We forecast that the Federal Reserve will gradually reduce the federal funds rate and reach an assumed neutral rate of 3.1% by fourth-quarter 2026. We would expect these rate cuts to lower the cost of financing TOB trusts by lowering the tax-exempt rate of interest set on floater certificates commonly purchased by money market funds. This would lead to greater spread between the yield on the underlying bond and cost of financing the trust, incentivizing issuance. For more information on our outlook for the U.S., see "Economic Outlook U.S. Q1 2025: Steady Growth, Significant Policy Uncertainty," published Nov. 26, 2024.
Chart 1
Chart 2
Credit Remains Robust Despite Municipal Downgrades
Ratings among TOB trust certificates remain well positioned heading into 2025. On Nov. 21, 2024, we raised ratings on 306 TOB trust certificates following our upgrade of JPMorgan Chase & Co.'s core subsidiaries, including JPMorgan Chase Bank N.A. to 'AA-/A-1+'. We lowered ratings on 48 TOB trust certificates on Oct. 18, 2024, following our downgrade of Toronto Dominion Bank N.A to 'A+/A-1'.
Approximately 23% of our rated $24.6 billion floater certificates hold an 'A-1+' short-term rating as of the fourth quarter, up from less than 1% in the third quarter (see chart 3). JPMorgan Chase Bank N.A. is the second largest liquidity provider in our rated portfolio, supporting approximately $4.5 billion in floater certificates, behind Barclays Bank PLC (see chart 4). Exposure to Toronto Dominion Bank N.A. shrank to $600 million in the fourth quarter from $755 million in the first quarter.
Currently, all banks providing liquidity support and credit enhancement in the TOB industry have stable outlooks. More broadly, 80% of banking groups globally have stable rating outlooks, a trend we expect to continue in 2025. We see downside risks to bank ratings around corporate real estate deterioration, high corporate and government-sector leverage amid still-elevated interest rates, and evolving risks such as new technologies, climate change, and cyber. For more information, refer to our commentary, "Global Banks Outlook 2025: Cautiously Confident," published Nov. 14, 2024.
Chart 3
Chart 4
TOB trusts typically hold a highly rated underlying municipal bond, which is the basis of our long-term rating methodology in lieu of third-party credit enhancement. The top 10 underlying bond obligors in terms of exposure in the rated TOB trust portfolio back approximately $5.6 billion or 300 ratings (see table 1). Among the 10 underlying bond obligors, all 22 security types hold long-term ratings in either the 'AA' or 'AAA' rating categories (see table 1).
Removing bank rating actions, our upgrade-to-downgrade ratio was 0.6x as of the end of 2024 (see chart 5).
The largest rating action in 2024 followed the placement of our ranking on the City of Chicago on CreditWatch negative. We subsequently placed 13 ratings on TOB trust certificates on CreditWatch negative. We have since lowered the ratings on all 13 certificates following the lowering of our rating on the City of Chicago to 'BBB/Stable'. For more information, see "Chicago; General Obligation," published Jan. 15, 2025.
On Jan. 14, 2025, we lowered long-term ratings on nine TOB certificates following the downgrade of Los Angeles Department of Water and Power. We currently rate 91 TOB certificates financing projects located in Los Angeles County and the surrounding area. For more information see "Los Angeles Department of Water & Power Ratings Lowered Two Notches To 'A' (Power) and 'AA-' (Water) On Increased Risks".
Table 1
| Top 10 tender option bond underlying bond obligors | |||||
|---|---|---|---|---|---|
| Underlying bond obligor | Security type | Lien (if applicable) | Long-term rating | Trust par amount (mil. $) | Trusts |
| The Triborough Bridge and Tunnel Authority | Miscellaneous tax | - | AA+ | 501 | 23 |
| Sales tax | - | AA+ | 513 | 18 | |
| Toll roads and bridges | - | AA- | 265 | 15 | |
| New York City Transitional Finance Authority | Miscellaneous tax | - | AAA | 630 | 30 |
| Non-School state programs | - | AA | 116 | 2 | |
| Sales tax | - | AAA | 70 | 5 | |
| State of New York | Appropriations | - | AA | 13 | 1 |
| Miscellaneous tax | - | AA+ | 465 | 24 | |
| Sales tax | - | AA+ | 173 | 8 | |
| New York City Municipal Water Finance Authority | Water/Sewer | - | AA+ | 535 | 30 |
| Massachusetts | Gas tax | - | AAA | 151 | 8 |
| General obligation | - | AA+ | 345 | 18 | |
| Miscellaneous tax | - | AAA | 64 | 2 | |
| Los Angeles International Airport | Airport | Senior | AA | 120 | 11 |
| Airport | Subordinate | AA- | 261 | 15 | |
| New York City | General obligation | - | AA | 266 | 20 |
| Sales tax | - | AA | 39 | 3 | |
| University of California | Public college/university - limited student fees | - | AA- | 50 | 5 |
| Public college/university - unlimited student fees | 1st Lien | AA | 133 | 5 | |
| Public college/university - unlimited student fees | 2nd Lien | AA- | 231 | 10 | |
| Texas Water Development Board | State revolving funds/pools | - | AAA | 332 | 18 |
| Pennsylvania Housing Finance Agency | Single family whole loan | - | AA+ | 321 | 18 |
Chart 5
Securitization Should Trend Back Toward Rated Municipal Bonds Following Rate Cuts
As spread opportunities emerge for TOB trust sponsors, we expect a return to a more even sector distribution. Throughout the first half of 2024, unrated municipal debt securitizations dominated as sponsors sought higher yield opportunities to offset a higher cost of financing. Following rate cuts later in the year, we saw an uptick in the securitization of rated municipal debt (see chart 6).
We rated approximately $242 million of TOB trust certificates repackaged with private utility debt (see chart 6). To note, approximately $96.6 million of this debt is backed with senior secured debt issued for the Florida-based train operator and manager, Brightline Trains Florida LLC. On May 8, 2024, we assigned a 'BBB-' long-term rating to Brightline Trains Florida LLC's $2.219 billion of senior tax-exempt bonds. For more information on the project, see "Brightline Trains Florida LLC's $2.219 Billion Senior Secured Debt Assigned 'BBB-' Rating; Outlook Stable".
Despite the uptick in the securitization of unrated debt, rated debt represents 83.3% of the rated TOB trust portfolio (see chart 7). Tax-secured debt accounts for the largest share, comprising 25.4% of the portfolio.
Chart 6
Chart 7
Fund Sponsored Issuance Bounced Back In Second-Half 2024 Following Fed Rate Cuts
We expect fund-sponsored TOB trust issuance to rise as the short-term cost of financing falls. Barclays Bank PLC and Deutsche Bank AG were the most active bank sponsors, issuing approximately $1.3 billion and $800 million rated certificates, respectively, in 2024. While bank sponsors were actively securitizing unrated municipal debt last year, fund sponsors were far less active in the sector. This is partially driven by the underwriting hurdles around unrated debt, which requires credit-enhancement by a bank. See chart 8 for a breakdown of rated issuance by sponsor in 2024 and chart 9 for a sponsor breakdown by outstanding trust par amount as of Jan. 1, 2025.
Citibank N.A. setup nine TOB trusts issuing a total of $305 million in rated certificates under their new 3a-7 compliant program in 2024. Approximately $150 million of the certificates are backed by unrated multifamily housing debt. Rated certificate holders benefit from credit enhancement provided by Citibank N.A. at a separate custody receipt level, which is then held by the TOB trust. The credit enhancement fully covers the principal and interest payments due on the underlying unrated bonds.
We rated issuance sponsored by several new fund sponsors in 2024, such as First Eagle Investments and John Hancock Investment Management. Notably, First Eagle Investment's High Yield Municipal Bond Fund, which is a mutual fund, has sponsored approximately $287 million in rated issuance. We also rated approximately $186 million of issuance sponsored by new private fund sponsors in 2024.
Chart 8
Chart 9
Average leverage, as measured by outstanding par of floaters-to-residuals across the rated fund-sponsored portfolio remained consistent at 2.98x as of the fourth quarter compared to 3.02x as of the second quarter (see chart 9), a decrease primarily driven by lower levered trusts set up in the third quarter. Fund sponsors determine their optimal leverage levels based on several factors, including the fund's total portfolio leverage, long-term municipal bond yields, and the short-term cost of financing.
The more a TOB trust is leveraged, the greater the impact interest rates will have on the fund's short-term performance. As interest rate cuts continue into 2025, we expect leverage will at least remain consistent and may rise as fund sponsors take advantage of a lower cost of financing. For more information on how fund sponsors create leverage with TOB trusts, see "U.S. Fund-Sponsored Tender Option Bond Leverage Remains Elevated As Short-Term Losses Rise," published Jan. 26, 2024.
Chart 10
Related Research
- Chicago; General Obligation, Jan. 15, 2025
- Los Angeles Department of Water & Power Ratings Lowered Two Notches To 'A' (Power) and 'AA-' (Water) On Increased Risks, Jan. 14, 2025
- Economic Outlook U.S. Q1 2025: Steady Growth, Significant Policy Uncertainty, Nov. 26, 2024
- JPMorgan Chase & Co. Upgraded To 'A/A-1' On Franchise Strength And Expected Continued Solid Performance; Outlook Stable, Nov. 15, 2024
- Global Banks Outlook 2025: Cautiously Confident, Nov. 14, 2024
- Brightline Trains Florida LLC's $2.219 Billion Senior Secured Debt Assigned 'BBB-' Rating; Outlook Stable, May 8, 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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