The New York City Transitional Finance Authority may have found the perfect deal structure to take advantage of the lack of short term paper in the market.
The unique structure the TFA used during its latest issuances in July and April generated such heavy demand that the authority was able to lower yields for both deals. Bonds available during the July deal's institutional sale were two times oversubscribed, and the bond appealed to a diverse range of investors. In addition to the retail and institutional buyers who are usually attracted to New York credits, money market funds gobbled up 15% to 20% of each deal.
The TFA ignited this fever for its bonds by issuing the deals in two parts, with the bulk coming as multi-model bonds with an optional mandatory tender, and the rest issued later in the month as variable rate debt.
Alan Anders, deputy director for finance at the mayor's Office of Management and Budget, estimated the authority was able to shave 25 basis points off the yield of the mid-July issuance even though the market was flat.
"Part of pricing of the July issue was based on secondary market trading of April issue," he said in an interview. "Our spreads did better in secondary trading than the general market place."
Investors are starved for short term paper because volume has been low this year overall. Issuance totaled $177.2 billion as of July 31 compared to $209.2 billion for the same period last year, according to information provided by The Bond Buyer and Ipreo.
Short term issuance in particular has remained at low levels, according to analysts.
The TFA has issued debt that is part fixed rate and part variable in the past, but the multi-model part of the two deals with the optional mandatory tender is new. It is critical in the current short-term paper starved market environment because it provides investors with a place to put their short term cash, locking in on the current attractively low interest rates.
The TFA deals' mandatory tenders are unusual because they kick in at 10 years, while ordinary tenders are usually in five years or less. Essentially, investors can keep their cash safe locking in on the same low interest rate for twice as long.
This type of tender is also atypical because it is optional. Instead of being a hard put, the TFA can call the bonds in 10 years and then remarket them back at a new rate or a new mode, giving the TFA more liquidity than it otherwise would have had.
Anders said the tender is optional because the TFA wanted an additional feature change mode rather than just a call, because there might be a yield advantage in changing the remaining maturities.
Fred Bacani, Head of Fixed Income & Trading at Veritable LP in Newtown Square, Pa, said in an interview after the mandatory tender portion of the deal was sold to institutional buyers in July that one of the bankers he spoke to was surprised he did not receive many calls about how the deal was structured. Bacani said in the new issue market the bonds received heavy demand, even though the structure provides that holders may be forced to tender their bonds when reinvestment is less favorable.
The July deal that "had the mandatory tender feature after 10 years was fixed rate," John Puig, a Managing Director in the New York City and Albany, New York Municipal Finance offices of RBC Capital Markets, said in an interview. "It really preserved a number of options for the city if opted to make any changes after the first 10 years. I believe that deal, again, was strongly received. It was several times oversubscribed."
For the April issuance the $760 million sold that had the optional mandatory tender had yields lowered as much as four basis points on some of the maturities due to high investor demand, and received high interest from both retail and institutional investors, with retail buying $200 million of the deal during the two-day retail order period before the institutional sale.
Bonds from the July sale had their yields lowered as much as five basis points from the start of their retail order period to the end of their institutional sale, and with $225 million going to retail and the rest of the $675 million total sale going to institutional buyers.
The spread between the April and July issuance also tightened, ranging from a spread of five basis points on the three year maturity to 38 basis points on the 25 year maturity for the July issuance, compared to Municipal Market Data's triple-A general obligation benchmark on July 15, the day before the bonds entered their institutional sale period.
The spread for the April issuance ranged from negative five basis points on the three year maturity to 37 basis points for the 26-year.
Michael Schroeder, president and chief investment officer of Wasmer, Schroeder & Company, said in an interview the deal's attractiveness is also increased by its variable rate portion because "there aren't enough [variable rate] deals to fill all the money market demand out there."
The variable rate portion of each issuance came to market one or two weeks after the fixed rate part, when sales on the fixed rate part close, according to Anders. Each of the variable rate parts of the deals totaled $200 million.
"Given the attention to the vehicle on first day we were able to price at an annualized rate of four basis points or .04%," Anders said. New York variable rate paper that prices at a new rate every day was at five basis points, he said.
Anders said the variable rate part of the deal was bought up by money market funds.
Bacani acknowledged the appeal of variable rate paper to money market funds, but said that he is not looking at that type of product himself.
"The adjustable rate structure is a daily reset," he said. "The rate for me, given how low short term rates are, was not that appealing. I am indifferent and could otherwise simply purchase a money market fund that consists of a diverse list of this type of structure. Most of the demand [for the variable rate TFA issuance] is within the money market sector."
He said that his interest in variable rate bonds may change when the new rules the Securities and Exchange Commission passed in July that will require money market mutual funds to adopt a floating net asset value.
"[A]mong other things, institutional prime and tax-exempt money market funds will have to float their net asset value- NAV-in two years," he said. "Money market funds will have to float their NAV, so a rate rise will have an adverse impact on the underling portfolio, and investors may receive less than their original principal. For me, I'm indifferent between buying a NYC TFA daily float versus a money market fund, but in two years this [VRDO] structure will become a lot more attractive given the par put feature and the new money market reform rules regarding floating NAVs."
Anders said that going forward both the TFA and New York City will try to have variable rate on most issuances. The authority's next issuance will probably be in the fall.
