What’s in a tender offer?

Transcription:

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Lynne Funk (00:04):

Hello everyone and welcome to The Bond Buyer podcast, your essential resource for insights into the world of public finance and municipal market strategy. I’m Lynne Funk, senior director of strategy and content – live media with The Bond Buyer. In this episode, The Bond Buyer’s Caitlin Devitt speaks with Nikolai Sklaroff, Capital Finance Director of the San Francisco Public Utilities Commission. At the recent GFOA annual conference, Nikolai and Caitlin discussed the growth of tender offers as a refunding alternative, how issuers have been executing them, and exactly how much investor interest they’ve been getting for them to make them worthwhile. Because of this growth, the GFOA also released a first ever best practice on the transactions. So let’s dive in.

Caitlin Devitt (00:50):

Hi Nikolai, thanks so much for joining us.

Nikolai Sklaroff (00:51):

Thank you, Caitlin.

Caitlin Devitt (00:52):

We’re here at the GFOA annual conference. It’s in Washington DC this year. So we’re actually in a little room at the convention center. The sessions have just started today, but yesterday was a big, the sort of annual debt committee meeting, which is an all day long committee that the GFOA holds as part of its annual conference. And we write about it at the bond buyer and we cover it. But one of the things that I wrote about that I thought was interesting that I wanted to talk to you about was you guys did a first ever best practice on tender refundings. And so let’s dive a little bit into this sort of complicated and market driven tool. And why don’t you start by telling us what are tender refundings?

Nikolai Sklaroff (01:35):

Sure. Tender refundings are really an opportunity for the marketplace to refund bonds that don’t normally get refunded. Normally when we refund bonds, we use the optional call. We get to control the process. There are times when we can’t refund bonds because of call provisions because they are taxable bonds that didn’t have call or make whole calls. We can use the tender process to bring those bonds back for refunding. It’s a very different process and it’s a process we’ve never described before in the best practices. Part of that is it’s such a market driven financing tool. Tenders historically have been used to resolve legal issues in documents, and it’s only more recently that we’ve had this very large wave of refundings that are taking advantage of two things. One is that in the wake of the 2017 Tax Act, when advanced refundings were eliminated on a tax exempt basis, the market shifted to using taxable bonds for advanced refundings. So we had a large number of bonds refunded that qualified for tax exempt financing, but used taxable financing instead. And so the tender is a process that we can use to bring those back, even though many of those have make whole calls and not only restore optionality, but actually achieve savings at the San Francisco Public Utilities Commission. We’ve now done it twice in the last two years.

Caitlin Devitt (03:29):

Okay. I want to get to that, but first let’s just take a little bit of a step back. So with the tender you, you’re offering existing bond holders, you’re asking them to tender their bonds.

Nikolai Sklaroff (03:41):

We don’t have the right to tell them.

Caitlin Devitt (03:43):

You don’t have the right to tell them because they’re not callable. We’re

Nikolai Sklaroff (03:46):

Giving them an option. Right. And in essence, what creates this opportunity is that interest rates have recently gone up after a prolonged period when interest rates were down. And as a result of that, bonds are trading well below part and we have the opportunity to offer them a price that is more advantageous to those issuers who are interested in selling the bonds and yet provide us with savings. So it creates a win-win

Caitlin Devitt (04:18):

Opportunity. Okay, and that makes sense. That’s why it’s so market driven is because it’s dependent on interest rates and at that price at which you can offer, and then to finance it, some issuers to finance the purchase of those bonds. Some insurers use cash. I know Florida did a cash deal, I think for a lot. I don’t know how many. I think they floated, they offered 1.4 billion. I don’t know how many participated, which is another question I’m going to ask you about. Typical participation rates, but then also what you’re talking about and what is more common is the issuer will borrow, a refund, will borrow to finance that tender. That’s right. Is that right?

Nikolai Sklaroff (04:59):

In order to make the tender worthwhile to get enough savings, typically you have to offer the tender for many more bonds than will actually be tender. You asked about participation levels. We’ve seen some as high as 70% and some as low as 10%. A very typical number would be 30% as an assumption. And that’s how often the bankers will run the numbers that they’re showing to us. Identify a pool of candidates, assume that maybe 30% get cheap. Now, sometimes people will re-tender bonds a few years later, and for those you might assume that even less we’ll get tendered. The second time we had that situation on some of our bonds. So for example, we assumed 30% on bonds that we had never tendered before and then 15% on others.

Caitlin Devitt (06:01):

And so is it still worth it at 15%?

Nikolai Sklaroff (06:03):

Well, I think that’s one of the important lessons in the best practices that we develop, which is that you need to make sure that the juices worth the squeeze. And it’s one of the reasons why in practice we recommend that people only move forward with a tender when they’re doing other transactions where there’s a better predictability that the transaction will get done because ultimately you really don’t know what the investors will choose to do. And different investors have different appetites for holding onto bonds or 10 green bonds.

Caitlin Devitt (06:50):

Yeah. Okay. So to go back to some pickup on something you said earlier, the reason why the GFO has developed this or got the idea, you could tell me a little bit more for the best practices because the market has jumped so much since tax exempt advance where fundings were eliminated in 2017 as part of the Tax Cuts and Jobs Act, and then bankers started pitching it right as a way to refund not currently refundable debt. And I saw from yesterday, you showed me a number that said the market went from like zero to 48 billion between 2019 and 2024, I think. Right. So that’s how much we’ve seen that kind of, I think what you would call exponential growth in that market that we’ve seen since then. So that’s pretty big in the last few years.

Nikolai Sklaroff (07:41):

That’s right. In a very short time, this marketplace has grown exponentially. A lot of people are facing the choice whether to do a tender or not having had prior experience. And in fact, as you look at the marketplace, there are many intermediaries, MAs attorneys who have had more or less experience because it is such an episodic type of financing. There are many people who are quite experienced who’ve never had experience with a tender bond. That’s why we’ve decided this is really an area that requires some guidance from the GFOA.

Caitlin Devitt (08:26):

Yeah, I mean, I think you said yesterday there’s a lot of private, there might be private firms out there, private guidance or whatever, but there’s nothing really public in a public realm for issuers.

Nikolai Sklaroff (08:37):

And I think that’s really the important role that GFOA plays with their best practices is providing guidance and information that’s free from commercial priority and objective information that’s been heavily vetted as this has been.

Caitlin Devitt (08:56):

Yeah. So tell us a little bit about your experience at the commission.

Nikolai Sklaroff (09:00):

So we are really excited and happy with the refunding experiences we’ve had. We’ve now done two tender refundings for our water enterprise. Each of those was accomplished at the same time that we’re also doing new money, although in the end, we ultimately stripped them apart, took advantage of the same disclosure, but kept the disclosure separate so that we wouldn’t confuse people with it. And in each case achieved tremendous savings. That for us, particularly on the taxable bonds, was really found money, in other words, bonds that we never had the expectation that we would be able to fund, particularly with the make whole call for savings. We achieved savings. And at the same time, we also took advantage of the opportunity to accelerate the savings on certain tax exempt bonds at the same time. And it’s a process where you don’t get to know with certainty either what savings you’re going to achieve or which bonds will ultimately be refunded. So we’d certainly prefer to have advance refunding capabilities on a tax descent basis, but in lieu of having that, it’s been a powerful tool for us.

Caitlin Devitt (10:27):

So what kind of participation did you see in those deals?

Nikolai Sklaroff (10:30):

In each case, it was very much along the lines that were predicted in excess of the 30%. I don’t have the specific numbers in front of me right now, but we were very pleased with those savings levels.

Caitlin Devitt (10:47):

Is it more institutional buyers or retail buyers or is it a mix?

Nikolai Sklaroff (10:51):

Well, it’s the interesting thing is that different buyers have different appetites for the tender. Some won’t consider it at all. Some simply won’t sell bonds at the loss.

Caitlin Devitt (11:07):

And is that because they’re saying they just have a buy hold mentality? Yes. They’re not even messing around.

Nikolai Sklaroff (11:13):

But for those buyers who might’ve wanted to exit the bonds for whatever reason, it’s an opportunity for them to sell the bonds at a higher price and benefit in that way. And undoubtedly there are others who are enticed who weren’t considering it, but decide to take advantage of the better price that they can achieve through the tender. One of the interesting parts about the tender is, and what makes it so different for issuers, is this process of informing the marketplace so that everyone has the same information. And this series of Emma notices that get issued even before the bonds are issued.

Caitlin Devitt (12:04):

The series, I’m sorry to interrupt, but the Emma notices announcing the tender announcing that the issuers tendering or offering

Nikolai Sklaroff (12:11):

Not only in our case, we issued a notice that we would be refunding the bonds. When we got to the point where we’re ready to do the bonds, there’s a whole sequence of notices that get issued to announce the prices that are being offered, the acceptances of those prices. Because one of the important things to understand is even as you’re going through the process, some bonds may be economic and some may no longer be economic because the market is changing, interest rates are changing. Normally that is all happening behind the scenes in the structure. But now it’s a very public process where you’re having to keep the investors informed about what decisions are being made. And then after the bonds have been refunded, of course, and there are even more Emma notices. So you really get to know Emma through this process, but you also get to learn about parts of the marketplace. I am embarrassed to admit that as a former investment banker, I had really no idea about this whole world of nobos and all the mechanics in the marketplace for being able to identify buyers. So there are, what are nobos?

Caitlin Devitt (13:45):

I don’t know what that is. What is that?

Nikolai Sklaroff (13:48):

So the investors have the ability to restrict or not whether their information is available. So there are firms, tender agents who help us to identify those buyers and really help the dealers to identify those buyers with names that I’d never heard of before, GLO and others. And so it’s a whole aspect of this process that most issuers aren’t familiar with. But I think as an industry, we have very well-oiled machinery from our underwriters, our MAs, for evaluating our success in pricing bonds. I think most of us as issuers really don’t know the mechanics of secondary market pricing and how much art and science go into those pricing decisions where you really get to know that through a tender process. And this whole discussion of BVAL versus MMD really comes to the fore. And we’re seeing people as exploring other mechanics for leveraging, for example, bval information in a tender process.

(15:28):

Recently saw the first tax exempt index off of bval by another issuer. So I think it’s important for issuers to understand how to evaluate all of that before they get to the pricing and tender process and really develop the models. We have the advantage, maybe the excessive advantage that we typically use two MAs on every transaction, plus a pricing consultant when we’re doing a negotiated sale. And so being able to evaluate the different information that’s available out there. And I think one of the parts of the guidance here is not to simply rely on your traditional providers, but really to search for people who understand the tender market because different people have more or less experience in that marketplace. So being very thoughtful about how you’re selecting the team and then how you’re developing the decision-making along the way, because certain market participants will suggest that there may be only one way of doing a tender. And I think in reality we’ve found that there are many ways to create bespoke tenders that are right for issuers.

Caitlin Devitt (17:01):

Yeah, that’s interesting. And you said that yesterday that there actually are many ways to do it. So it sounds like it’s kind of fascinating because of that secondary market pricing aspect, which as you say, cities and states issuers aren’t necessarily used to that. They’re used to the primary market. So then you’re getting into the secondary market. You’re getting into all those pricing issues. So take you guys. How long have you been working on the best practices?

Nikolai Sklaroff (17:26):

Well, first of all, it’s taken entire committee, in fact, two committees. So we had a changeover of committee, and so we had some members who participated early, and others have seen it all the way through. But it has been a multi-year project. In part, it’s also that this is the first one under a new process that GFOA has adopted to integrate staff and committees in that effort. And so I think we’re very excited about how this turned out.

Caitlin Devitt (18:04):

So when can we see those? Do you know when we can see that getting published?

Nikolai Sklaroff (18:08):

I understand from staff that publication is imminent.

Caitlin Devitt (18:12):

Oh, awesome. Okay. Great. Alright. Anything else you wanted to add about it? Neglect?

Nikolai Sklaroff (18:16):

No, I do think this is an area that has grown very quickly. We were both just in a session here at the GFOA where tenders were discussed once again, and we hope this is an important new tool for issuers when it comes out.

Caitlin Devitt (18:34):

Unless we see advanced tax accepted advanced refunding come back,

Nikolai Sklaroff (18:38):

We’d all be very excited to see that happening.

Caitlin Devitt (18:41):

Well, thank you so much for your time. I appreciate it.

Lynne Funk (18:44):

And that’s a wrap for this episode of The Bond Buyer Podcast. A big thank you to Nikolai Sklaroff and to The Bond Buyer’s, Caitlin Devitt. A few key takeaways.

Number one, in a very short time, this marketplace has grown exponentially — from 2019 to 2024, the tender refunding market ballooned from zero, yes, zero to $48 billion.

Number two, to make the tender worthwhile to get enough savings, typically issuers have to offer many more bonds than will actually be tendered. And a typical tender gets about 30% investor participation.

And three, the tender offer requires a much more public process of keeping investors informed about what decisions are being made. And it’s much more of a market driven financing tool than issuers have been used to doing. Hence the GFOA’s new best practice.

Thanks again for listening to The Bond Buyer podcast. This episode was produced by The Bond Buyer. If you liked what you heard, please subscribe on your favorite podcast platform. Leave us a review and visit us www.bondbuyer.com for more of our award-winning coverage. I hope to see you all soon. I’m Lynne Funk, signing off.