Despite swings in short-term rates, issuance of variable rate demand obligations and other floating-rate debt has steadily increased over the past several years, with variable rate (short put) issuance so far in 2024 rising to $5.972 billion, a 6.4% increase year-over-year, LSEG data shows.
Issuance rose to $13.239 billion in 2023 from $11.533 billion in 2022, an increase of 13.8%, according to LSEG data.
Though it’s unlikely to reach pre-financial crisis levels due to fewer issuers using the structure due in part to past losses, current market volatility and an inverted yield curve, this week sees several issuers coming to market with deals. This marks a change from the start of the year when
The VRDO deals this week are more of a “strategic” approach for cash needs, said Chris Brigati, senior vice president and director of strategic planning and fixed income research at SWBC.
“Issuers have been very cautious about using cash as a vehicle because of the high cost of them due to the inverted yield curve,” he said.
The Bay Area Toll Authority is one such issuer that has used the tool.
The authority priced on Tuesday $200 million of variable-rate San Francisco Bay Area Toll Bridge revenue bonds in two tranches: $150 million of 2024 Series H bonds and $50 million of 2024 Series I bonds. Both were priced to yield 4.05%.
The proceeds will be used to fund the authority’s rehabilitation program for the bridges, said Derek Hansel, the Bay Area Toll Authority’s CFO.
“We have a large, reasonably complex and diverse debt portfolio,” he said. “We have a lot of variable-rate and other short-term project paper out in the marketplace. We also have a large interest rate derivative portfolio and a large investment portfolio. So we look at the mix of variable-rate and fixed-rate debt in that context and try to maintain an appropriate balance among those product sites that we think is best for the agency.”
The Bay Area Toll Authority came to market several weeks ago, at the beginning of the month, with $596.065 million of fixed-rate San Francisco Bay Area Toll Bridge revenue bonds in three tranches.
The authority believes the paper will price “quite well,” as demand will be similar to its other letter credit-backed variable-rate paper, according to Hansel.
“We’re comfortable with what we’re doing this week, and the rating agencies and investors are comfortable with us taking on some additional portion of floating-rate debt,” he said.
The recent levels of VRDO issuance pales compared to issuance before the financial crisis, with VRDOs falling from its high of $61.8 billion in 2005 by nearly half to $32.333 billion in 2009 and almost in half again, to $15.017 billion, in 2012, according to LSEG data.
During the pre-financial crisis, the short-term market was mostly used to achieve a lower synthetic rate, with the VRDOs connected to an interest rate swap where the issuer would receive floating payments.
However, after the financial crisis, few issuers engaged in swaps, with issuance becoming more “concentrated,” said Lisa Washburn, chief credit officer and managing director at Municipal Market Analytics.
Issuance is usually done by hospitals, housing agencies, and some higher education institutions and universities, along with issuers with more “financial management functions,” she noted.
VRDO issuance has “fallen out of favor” due to the inversion of the yield curve and long-term rates are tighter than historical highs, said James Pruskowski, chief investment officer at 16Rock Asset Management.
Issuers are now funding their needs rather than “recycling” into flows and there is no budgetary pressure in terms of tax receipts and rainy day funds, he noted.
Collections have been running at a “robust rate,” alleviating pressure to finance any short-term needs, Pruskowski said.
Uncertainty over the timing of when the Fed will start cutting rates is also playing a role, said Rick White, an independent consultant with more than 25 years in the industry.
“It’s hard for an issuer to stomach issuing a floating-rate piece of paper at rates over 4% versus a long-term fixed-rate deal at very attractive rates,” he noted.
Additionally, “people are looking for ways to lock in higher yields, so they’re getting less involved and having less than an appetite for the VRDN space,” Brigati said, noting that may exacerbate any of the expected market volatility.
There have been stretches of volatility this year, as seen in the whipsawing figures from the SIFMA Municipal Swap Index Yield over the past few months.
January saw wild swings before entering a more “normal” environment with slight increases in February through April before volatility spiked in May and continued through June, White noted.
For the week ending May 22, the SIFMA Index was at 3.42% before ticking down 6 basis points to 3.36% for the week ending May 29. From there, the index fell 47 basis points to 2.89% for the week ending June 5 before rising 29 basis points to 3.18% to end the week of June 19. The index surged 91 basis points to 4.09% for the week ending June 19.
However, the recent spike in SIFMA can be attributed to money coming into the tax-exempt money market funds before leaving, coinciding with the excess supply of VRDOs, Washburn said.
For the six-day period ending May 15, tax-exempt money market funds decreased by $2.758 billion to $126.313 billion, according to the Investment Company Institute.
Following that, there were three periods of inflows, increasing by a total of $4.39 billion to $130.703, ICI reports.
However, after there were recent outflows for the period ending June 12 and June 18, a decrease of $2.723 billion to $127.98 billion, ICI reports.
Despite the recent volatility, White said it has “calmed down” from the “incredible” volatility of 2023 where the SIFMA Index saw weekly changes of more than 50 basis points for 27 weeks.
He notes the size of the market plays a large part in that, as it is just a “fraction” of what it once was.
Furthermore, the volatility heading into July — one of the best seasonal months with the most amount of cash returning to market — can be cyclical.
With the week ending Wednesday, the SIFMA Index topped 4%, similar to June 2023 when it was over 4% for two consecutive weeks ahead of July.
Despite market volatility, floating-rate products offer issuers flexibility, White said, noting that many of the larger issuers have variable-rate debt in both daily and weekly mode and can convert to other modes if their bond documents allow.
“Having debt issued in daily mode versus the more common weekly form is benefitting municipal issuers as the overall interest savings are dramatically better than it has been historically,” he said.