Due to market changes over recent years and the absence of tax exempt advanced refunding due to the 2017 Tax Cuts and Jobs Act (“TCJA”) tender refunding has emerged in the municipal market as a strategy to extract savings from, or to make other strategic portfolio changes to, transactions that cannot otherwise be refunded efficiently or timely. Such transactions are inherently cyclical, and many experienced governmental issuers have not worked in economic environments when tenders were common due to the past availability of the more flexible tax-exempt advance refunding tool.

These tender refunding transactions have complexities and risks beyond traditional refunding. Because this tool is not routinely available in the marketplace, issuers have little independent information and guidance to refer to in making decisions about entering and conducting a tender refunding process.

Between 2019 and 2024, the market for tender refundings of municipal bonds increased to its current level of approximately $48 billion, according to tracking numbers provided by multiple investment banks1. The reason for this growth for this specific transaction is driven by its flexibility: unlike a traditional refunding in which an issuer can call bonds from investors, the tender refunding is a strategy that allows issuers to purchase bonds directly from willing investors by finding a price to pay for the bonds that is attractive to the investors and sufficient to meet the issuer’s refunding goals.

The sudden rise in interest rates after years of unnaturally low rates has meant that many outstanding bonds issued when rates were low are now worth less. The fundamental pricing principle of bonds is that the price on outstanding bonds goes down as rates rise (i.e. the price of bonds with low interest coupon rates goes down because investors can buy new bonds paying higher rates). For example, today it might be possible to offer investors 86 cents on the dollar for bonds trading in the secondary market at 84 cents. In this context, a properly priced tender can be a win-win for both the issuer and the investor.

The issuance of tenders has also been driven by issuers who want to refund taxable bonds issued with limited call flexibility, with tax exempt bonds with a par call. This is especially true if an issuer only issued taxable bonds (although the underlying project qualifies for tax exempt status) as in the example of taxable advance refunding necessitated by the passage of the 2017 TCJA and the elimination of tax-exempt advance refunding.

For purposes of this best practice, we will assume the issuer will be issuing refunding debt to fund the purchase of the tender bonds, although an issuer can execute a tender of bonds with cash if they have the means and the desire to do so, without issuing refunding bonds.

GFOA recommends the following specific strategies to successfully execute a tender refunding of municipal bonds:

• Include the handling of tender refunding in the issuer’s written debt policies.

The adoption of written policies represents an opportunity to educate elected officials and staff about the unique nature of the tender process. A poorly managed tender could disrupt bondholder relationships and cause lasting damage. While many issuers have refined strong practices on how to execute traditional current refunding bonds, many debt policies are silent on tender refunding. Having a clear policy not only provides transparency but also protects the issuer by establishing rules of engagement. Many issuers refunding bonds leverage GFOA best practices on refunding bonds, which can be a great resource as issuers craft their tender policy

• Clearly articulate intended goals for the tender refunding (whether they be savings, indenture relief, debt restructuring) to ensure that the transaction aligns with those goals throughout the process.
• Engaging a financing team, including municipal advisors, bond attorneys and underwriters, with specific expertise and experience in tender refunding, potentially through dedicated solicitation of teams for such transactions.

 While the skills associated with issuing bonds have been widely refined across the market, the skills associated with setting prices for tenders and the process for managing tenders are neither familiar nor practiced by most market participants. Highly qualified municipal advisors, investment bankers and attorneys who have executed many tenders may have more experience with the different strategies and techniques for executing a tender appropriate to a given sector. For example, the tender setting process typically involves multiple disseminations of information to the market as the tender prices are being set for every series and maturity of bonds chosen as tender candidates. Some prices may be set by a spread to an index, others may be fixed, and when they are fixed the rate setting may be more ‘art’ than ‘science’ as finance professionals navigate different data points from Municipal Market Data (MMD) and BVAL (Bloomberg’s pricing evaluation service). Tender transactions also include participants in specific roles that are not widely known to municipal issuers, but who are critical to the successful execution of a tender (the Dealer Manager, Tender Agent, perhaps a Verification Agent, and agents to collect information about holders of the bonds, known as Non-Objecting Beneficial Owners or “NOBOs”). Advisors and bankers experienced in tender offerings can readily identify these professionals and coordinate their services, ensuring an efficient transaction and providing issuers the best opportunity for success. A solicitation of professionals dedicated to a contemplated tender offering may offer a better opportunity to retain a qualified team than reliance on existing pools for more routine bond financings and tender refunding.

• Consider only incurring the costs and work effort associated with a tender refunding transaction in combination with new money or a traditional refunding due to the inherent uncertainty of outcomes based on choices that will be made by investors at the time the transaction is executed.

Tender transactions are likely to take longer to execute than conventional refunding transactions and therefore may be more expensive to execute. They will typically involve additional specialized participants and additional documentation, including notices posted to EMMA. If a tender transaction is pursued, many of these costs will need to be paid, regardless of the outcome of the tender and how many bonds investors choose to tender. Participation in tenders can vary widely from transaction to transaction based on the nature of the existing holders, market condition and market expectations and the team’s success in determining rates and spreads that are sufficiently attractive to investors. Some may garner 70% participation or more, others may be only 10%. Many underwriters will run numbers assuming 30% of similar outcomes. For this reason, most tender transactions are combined with planned current refunding(s) or new money transaction(s) to spread the costs over more bonds and to increase the certainty that a transaction ultimately will be consummated to recover costs and staff time committed to the transaction. Issuers should make certain at the outset that the intended “juice is worth the squeeze” even if participation is less than hoped.

• A tender transaction involves not only the sale of refunding bonds, but also the purchase of outstanding bonds. Because of this, issuers should ensure that all decision makers clearly understand how the pricing of those bonds will occur and ensure that models are developed and reviewed in advance of the tender process. Pricing models should evaluate and set criteria around the fairness of such pricing, which may look very different than the analysis even seasoned bond issuers are accustomed to reviewing for a bond sale. The model should also include special attention to timing to make sure that the refunding bonds are only issued after the set of tendered bonds is known and accepted. Timing between these two milestones should be very short in order to limit market rate risk.

 There are three pricing methodologies that are generally considered for municipal bond tenders:

1. a fixed price option, where the issuer sets a target price for each bond offered for tender
2. a fixed spread option, where the issuer would specify spreads to given benchmark or index for each tender candidate that translates into a targeted tender price
3. a modified Dutch auction, where investors submit spread offers to a given benchmark security or index that again ultimately translates into a tender price.

 The pricing process may provide multiple data points – for example, multiple EMMA notices might include an Invitation to Tender, followed by a Pricing Notice, a Preliminary Acceptance and a Final Acceptance Notice, and these may have even been proceeded with an earlier Notice of Potential Bond Issuance and followed by various Notices of Redemption. The success of a tender is largely driven by investor participation, which makes the selection of dealer manager and municipal advisor all the more important. The dealer manager and advisor should ideally both be aware of who the holders of the target bonds are, their potential motivations to participate, and the pricing dynamics of the target bonds.

 Issuers should ensure they are comfortable with why a given methodology is being recommended and which indices will be used to determine rates. It may be that different methodologies will be applied to different bonds – for example a tender refunding that combines both taxable and tax-exempt tender candidates. It is worth noting that the market continues to innovate and evolve around tenders, so it is important to understand that there is no single right way to how to conduct a tender and issuers should carefully assess the appropriate options with an experienced team of advisors. Recently, for example, the market saw the first reported tax- exempt tender conducted based on an index, versus a fixed spread, using BVAL as the index. Each of these decision points requires evaluation and discussion with experienced municipal advisors and/or underwriters, as applicable.

 Because of the rapid nature of the tender process, issuers should ensure their teams review with them in advance how information will be presented and evaluated at each stage of the process, and it is helpful to have dynamic models that show how prices will be set and the expected savings from each maturity of each series of bonds proposed for tender.

Conduct Preliminary Analysis and Planning

• Engage Advisors: Retain a municipal advisor with in-depth experience and expertise in tender refunding to guide the process.
• Assess Refunding Viability: Have municipal advisors provide a cost-benefit analysis to determine the potential savings and costs. Identify target bond candidates needed to affect the desired result.
• Review Debt Policies: Ensure the issuer’s debt management policies support the refunding transaction.
• Engage Rest of Team: Hire bond counsel, disclosure counsel, bond underwriters/dealer-managers, and Tender/Information Agent with in-depth experience and expertise in tender refunding to help execute the transaction.

Ensure Legal and Regulatory Compliance

• Legal Review: Have bond counsel ensure compliance with federal, state, and local laws.
• Tax Considerations: Have tax counsel evaluate the tax implications, especially in light of recent tax law changes.
• Disclosure Requirements: Have disclosure counsel prepare necessary disclosures for investors.

Perform Market Analysis

• o   Monitor Market Conditions: Track interest rates and market trends to identify the optimal timing.
• Credit Rating Review: Obtain or update credit ratings if necessary and/or obtain bond insurance if advantageous.

Structure the Transaction

• Determine Refunding Structure: Decide on the type of refunding, and the structure of the new bonds, including tax structure.
• Draft Offering Documents: Prepare the Preliminary Official Statement (POS) and Official Statement (OS).

Authorize the Transaction

• Provide Staff Report and Draft Documents: Approve the transaction
• Communicate Appropriate Expectations. The issuer should be extremely careful in communicating results because results may be uncertain. Consider posting a POS that assumes limited participation, such as 30%, and show savings assuming such limited participation. Finaly, consider showing ranges and ensure language does not assume success is ensured.

Prepare Tender Offer

• Identify Holders of Target Bonds: Use Dealer Manager and Tender/Information Agent to identify holders to facilitate investor engagement.
• Develop Tender Offer Terms: Define the terms and conditions of the tender offer. Determine most advantageous pricing method (fixed price, fixed spread, Dutch Auction, etc.). Discuss strategies of length of offer period with deal team as well as ability to adjust offer prices during the tender offer period. The offer period typically runs 10 business days but can be shortened with additional DTC fees involved. Significant market movements during the offer period can have a material impact on the market prices of the bonds being offered for tender, so it is recommended that the issuer and MA discuss whether or not the ability to adjust offer prices should be contemplated in the offer (typically no less than 3-5 days prior to the close of the tender period). Include the right to reject any and all tender offers. Carefully evaluate and ensure there are appropriate opportunities to exit the transaction without penalty if market conditions become adverse or the refunding bonds are not sold (contingency). Issuers should include in their offer that the issuer has the right to reject and any all tender offers based on meeting certain economic measures.

Review Municipal Advisor Models to Be Employed in Advance of Sale.

• Ensure that all parties have a common understanding of what data sources will be employed and how pricing will be determined.
• Consider developing sample tender pricing ahead of the actual tender process to ensure issuer team is comfortable with the methodology and approach, well before the time pressures of the actual tender process.
• Notify bondholders of the tender offer and provide necessary documentation.
• Arrange for an escrow account to manage the funds.

Execution of the Tender Offer

• Launch Tender Offer: Officially launch the tender offer and begin accepting tenders from bondholders.
• Engage with Investors: Dealer Manager and Tender/Information Agent engage investors directly to determine likelihood of participation.
• Evaluate Tenders: Assess the tenders received and decide which bonds to accept.
• Finalize Terms: Finalize the terms of the accepted tenders.

Issuance of Refunding Bonds

• Pricing and Sale: Price and sell the new refunding bonds.
• Finalize Tender Terms: Based on pricing of refunding bonds, finalize the amount of accepted tenders based on established criteria, such a savings thresholds.
• Close the Transaction: Complete the legal and financial closing of the new bonds.
• Fund Escrow Account: Transfer funds to the escrow account to pay off the tendered bonds.

Post-Transaction Activities

• Settlement: Ensure the settlement of the tendered bonds.
• Reporting: Report the transaction to relevant authorities and update financial statements.
• Investor Relations: Maintain communication with investors and provide ongoing disclosures.

Ongoing Monitoring

• Monitor Savings: Track the actual savings achieved through the refunding.
• Compliance: Ensure ongoing compliance with all covenants and legal requirements.