Tender option bonds thrive when municipal bond market yields are high, so it's no surprise that as muni yields slipped in the first half this year, TOB issuance followed. Analysts still expect significant TOB formation and a possible rebound if rates cooperate.
"As the yields have come down, we've just seen quite a significant drop in issuance," said S&P Global Ratings analyst Liam Felter, an author of its July 27 report on the TOB market during the first half of the year. "In the same time period last year we had rated close to 450 trusts, and this year I think it was only 166."
Tender option bonds are trust investments used to create leverage in municipal bond portfolios.
They do so by borrowing primarily from money market funds or other cash-like investors to invest in high-quality municipal bonds, the firm Nuveen says
Bonds are deposited into the trust, which splits them into two types of securities: floating rate securities sold to money market funds, and inverse floating rate securities.
In Nuveen's example, the inverse floaters effectively enable a fund to borrow from money market funds to fund additional long-term fixed-rate debt it expects to yield more than the rate on the floating-rate securities.
General demand remains strong for tax-exempt fixed-income securities despite impressive muni bond supply.
"While multiple factors may have influenced market activity, the moderation in municipal yields may have reduced opportunities to establish new TOB structures, following a period in 2025 during which many sponsors had financed higher yielding collateral through TOBs," according to the S&P report.
Acknowledging TOB issuance is down, Municipal Market Analytics Managing Director Lisa Washburn said other factors may have contributed to S&P rating fewer trusts.
"TOBs tend to only get one rating," she noted, so they could have received ratings from Moody's Ratings or Fitch Ratings instead. "It's kind of hard to know exactly what the delta is from this particular report."
Washburn said TOB issuance is "tracking lower, but, depending on where rates go, it could pick up," depending on yields' movement.
"But it's really hard to predict unless you know where the interest rates in both the long- and the short-term are going to go," she said.
As longer-term yields drop, so does the incentive to issue TOBs, with firms considering whether they can make enough from the spread.
If short-term rates rally, TOB issuance may increase, but if there's compression in spreads, TOB activity is more likely to constrict, Washburn said.
"A lot of the activity that we saw last year had just sort of disappeared," S&P's Felter said. "I think a lot of that had to do, at least on the third-party space, with the yield environment. Even though there was record issuance this year, which you would think would drive up the yields, I guess demand has successfully absorbed that."
Cooling yields have not drastically impacted the muni market. Demand for munis continues to be supported by mutual funds, separately managed accounts, insurance companies, other institutional investors as well as substantial reinvestment cash flows — all of which helped absorb new issuance and boosted muni bond prices, according to the S&P report.
Even though S&P analysts expect TOB issuance to remain below 2025 levels, they still expect a continued "meaningful share of new TOB formation" from compliant bank-sponsored issuance, according to the report. "We expect the outstanding market to remain active as participants continue to refinance existing positions, restructure transactions, and adopt new approaches where appropriate."
