While a more common feature on corporate bonds and taxable munis, some issuers have priced recent deals with make-whole calls on their short-maturity tax-exempt bonds.
So far, the market does not appear to be penalizing issuers.
Two mega deals recently priced with make-whole calls for bonds due in 2034 and shorter where the market does not appear "to be penalizing issuers for including an optional make whole call feature in the short maturity tax-exempt bonds," said Pat Luby, head of Municipal Strategy at CreditSights, in a report.
"The tax-exempt bonds due after 3/15/2034 are subject to an optional call beginning 3/15/2034 at par, while the bonds due on or before 3/15/2034 are subject to an optional make whole call on any date," he said.
The 10-year DASNY bonds priced on March 14 at +30 and as of Thursday were at +19, according to BVAL.
The DASNY PIT bonds sold in September 2023 "did not have a make whole call provision for the tax-exempt bonds, and they were priced at +47 in 10-years," Luby said.
As of Thursday, the bonds were at +20," according to BVAL.
"The taxable series of the 2023 bonds due on or before 3/15/2033 are subject to an optional make whole call at any time until 2033, and at par beginning in 2033," he said.
The 10-year bonds were priced at +40, he said.
The prior sale from New York City in February also included an optional make-whole call that applied to the bonds due on or before 2034.
Those bonds were priced Feb. 29 at +20 and were evaluated by BVAL at +35 as of Thursday, he said.
If the two issuers had issued those bonds with 5% coupons with a regular muni optional call, Luby said in an interview that those bonds would have been priced to that very short call.
Furthermore, interest from buyers would have been a "tiny fraction" of what it would have been, he noted.
So the issuer would have paid a penalty because they'd have to accept a lower premium for those bonds if they had a traditional muni call, according to Luby.
"So this way the issuer obtains a little bit of flexibility for themselves to be able to potentially call them before 10 years," he said.
With the inability to advance refund preexisting debt, municipalities are trying to afford themselves all options for future risks, James Pruskowski, chief investment officer at 16Rock Asset Management, said.
"With interest rates, high ratios, fair value, and the multiple on yields given the tax-exemption to the top tax rate payers, the market is not penalizing various make whole call options," Pruskowski said.
However, Luby said there can be several concerns with the make-whole call due to the lack of "a convenient way for market participants to easily calculate current make-whole call prices."
For one, make-whole calls would redeem bonds at prices not "immediately obvious," especially for tax-exempts issued at a premium, he said.
This may lead market participants to "over- or under-estimate the possible risk of a bond getting called away, and therefore its longer-term prospects for performance," Luby said in the report.
For taxables, which are usually priced at par in the new-issue market, "the uncertainty of the make-whole call premium should be less of a concern (but not always, as the market is discovering now with the make-whole calls of old Build America Bonds)."
Make-whole calls have been highlighted following the
However, bondholders from the Regents of the University of California and
Luby said in the report "the complexity of optional make whole calls and the variability of the redemption prices will complicate investor disclosure and education efforts."
Previously, issuers could have saved money on their refinancing through advanced refunding bonds, but "that door has closed and is unlikely to open anytime soon," Luby said in an interview.
Therefore, while using a make-whole call is more expensive for an issuer, it gives them one more potential tool to use, he noted.
Make-whole calls are usually an "investor-friendly device," said Matt Fabian, a partner at Municipal Market Analytics.
The long end of the muni curve has been relatively weak versus the front end where the strong SMA demand has been "very well bid," Fabian said.
However, the back end has had a harder time attracting investors as mutual fund flows have been inconsistent and banks and insurance companies have reduced their muni holdings, he said.
"So to make their muni bonds more attractive to investors, more issuers may be willing to effectively give up their call rates on that bond through a make whole call structure," Fabian said.
Make-whole calls are less appealing for issuers, coming with concessions and limiting their ability to restructure, Fabian said, noting that most of the BABs with optional calls have been restructured in prior years, unlike BABs with make whole calls.
Make-whole calls appeal to investors, though, as it removes a lot of risk for the investor, who no longer has to worry about the bond being called early, reinvestment and can lock in current yields for the longer term in their portfolio, Fabian said.
A handful of deals each week have non-traditional call options, including make-whole calls, Pruskowski said.
"This is part of living in the post-tax reform world where municipalities are giving themselves optionality at these high interest rates. They need to finance; they want to buy options to afford refinancing in the future," he said.
Fabian does not expect a "meaningful" increase in make-whole calls.
Once the Fed starts to cut rates, the demand performance of muni bonds should improve.
And it's unlikely that issuers will have to resort to make-whole calls.
This, Fabian said, is most likely a temporary phenomenon in a market lull before the Fed starts to cut rates.
