High rates prompt new look at old bond structures

Rising interest rates may herald the return of “oldie but goodie” bond products that lost popularity during the decade-long low-rate environment.

So said panelists Wednesday during the Government Finance Officers Association’s annual Minimuni conference.

Issuers eying a borrowing should prepare for vastly changed market dynamics — and to manage public expectations on borrowing costs, panelists said.

“It’s probably a completely different market from the last time you issued debt,” said Susan Gaffney, executive director of the National Association of Municipal Advisors.

After a decade of enjoying near record-low borrowing costs, issuers are now facing fast-rising interest rates as the Federal Reserve tries to tamp down inflation. Overall issuance in 2022 has dropped significantly as a result.

But bond products that make financial sense with high rates —such as tender option bonds, variable-rate debt, direct bank placements and structures that shift between tax-exempt and taxable — are starting to pop up again in the market, panelists said.

Several TOB programs have come to market this year, “and that brings hedge funds and banks in” and “provides liquidity and give our investors options,” said Michael Imhoff, managing director at Stifel Nicolaus & Co.

TOBs are “a phrase no one has heard for the last 10 years but they’re re-emerging,” Gaffney added.

Even prepaid gas bonds are “an oldie but a goodie” that might start to make sense again, she said.

Variable-rate debt may also start to enjoy a comeback in the current environment.

Deals “where issuers can use variable rates and then take that out with fixed rate; I wouldn’t be surprised to see a structure like that,” said Tom Kozlik, head of strategy and credit at HilltopSecurities, Inc.

Pension obligation bonds, a controversial structure that rising rates actually make less workable, remain a possibility for some issuers, particularly in California, panelists said.

“All of these structures are important to the market,” Imhoff said. “The big thing is to keep liquidity in the municipal market, and having different options … is very important.”

Beyond niche products, the market has also sparked a shift in coupon trends, Imhoff said. During the third quarter of 2022, 60% of all deals used 5% coupons, compared to 33% in all of 2021, he said.

“Lower coupons made a lot of sense in that interest rate environment but now we’re seeing a big shift to the 4% and 5% coupon,” he said. “Investors want to be more protected in their coupons.”

Refundings make less sense with higher rates, but bankers are pitching “innovative” deals that generate savings, said Nikolai Sklaroff, capital finance director of the San Francisco Public Utilities Commission.

“We continue to receive proposals from the Street for refunding ideas, and shout out to our community; quite innovative,” Sklaroff said. “Notwithstanding the rise in rates, I think there’s still a lot of productive energy to be spent exploring these ideas.”