Update: Treasury has announced that the sale of SLGS is being suspended at 12:00 p.m. ET on Friday, December 8, 2017. SLGS subscriptions filed before 12:00 p.m. ET on December 8, 2017 will be honored.
As we reported on November 22 in this blog (SLGS Will Soon be Unavailable for Subscription), beginning on or before December 8, we should expect the reinstatement of the federal debt ceiling to force the SLGS window to close. The current suspension of the debt ceiling expires on December 8, and there is no expectation that the suspension will be extended or that the debt ceiling will be raised by that date. This unfortunately occurs just as the glut of tax-exempt advance refundings is hitting the market so that those issues can close before the possible (likely?) year-end deadline before such advance refundings are outlawed by the pending House and Senate tax bills (a discussion of the Senate bill is available here and here and a discussion of the House bill is available here). This points to open market escrow securities soon being the only game in town, raising questions as to the availability of bids and open market securities for all the escrows soon to require funding. I recently had the nerve in this exceptionally busy time to ask two of the most experienced bidding agent representatives I know for a few moments of their time to share their perspectives on the market for these escrow securities. Both were very generous with their time and thoughts, which I report below.
I spoke with Bill Glasso of Causey Demgen & Moore P.C. and another bidding agent representative who asked that I not use his name because of firm policy. Both were extremely helpful.
We first discussed experience to date in receiving the three bids required by the bidding safe harbor of the tax regulations. Both reported that so far they often have been able to get three bids. Given that bidding for open markets has already increased even before the SLGS window closes, this was good to hear and is consistent with my experience. However, not surprisingly they expect that receiving three bids will become much more difficult as the demand for open markets increases as a result of the number of advance refundings coming to market within a week or so in combination with the closing of the SLGS window.
The greatest difficulty in receiving three bids is expected, as always, with relatively small and large deals. For this purpose, small deals might typically be thought of as those below $15 or $20 million. But with the expected level of demand, I was cautioned to think of deals up to $40 or $50 million as being small and possibly having trouble attracting three bids. On the other extreme, issues requiring more than $250 or $500 million (the bidding agents could of course only provide ballpark predictions) of escrow securities are also likely to have trouble getting three bids. Bill Glasso explained that part of the difficulty in receiving three bids results from there now being only four active participants in the bidding for these securities.
I also asked whether they anticipate significant numbers of failed deliveries of escrow securities on the closing date in light of the high level of demand. They had mixed reactions to this question, one feeling some concern over the deliveries and the other seeing it as more of a brief timing concern, particularly if the closing is scheduled early in the morning. Of course, their requests for bids – as should all requests for bids – provides for alternative delivery of other securities or cash in the event the winning bidder is unable to deliver the intended securities.
Possibly of greatest interest were answers to the question of how bond counsel firms are typically reacting to the receipt of fewer than three bids, e.g., are they approving acceptance of the bid, requiring re-bidding, or something else? Based on the bidding agents’ responses, it sounds as though bond counsel have been reasonably consistent in approving the acceptance of the better of two bids provided the bidding agent can establish a good faith and competent effort to obtain three bids, the price offered by the winning bidder can be reconciled to contemporaneous open market trading, there is a material amount of negative arbitrage when comparing the escrow yield to the bond issue yield and at least two bids are received. Of course, in considering these requirements, bond counsel can afford to be more restrictive when the option of SLGS is available. In that case, non-acceptance of a bid means the issuer must buy SLGS, with the consequence being some increased escrow cost.
These judgment calls will become more difficult when the SLGS window is closed because there will be no alternative to purchasing the open market securities other than to re-bid the escrow (possibly with the same result of too few bids) or to cancel the refunding. This will be especially difficult where only one bid is received. That situation will likely often result in re-bidding. Also adding to the challenges that bond counsel will likely face, as issuers have looked deeper into their pool of refunding candidates to take advantage of possibly their last opportunity for advance refundings, are bonds with later call dates being chosen for refunding. The resulting longer escrow, in combination with rising Treasury yields, is reducing the amount of negative arbitrage. While this is good news for issuers, it makes bond counsel’s judgment when fewer than three bids are received more difficult because there will be less “cushion” if the IRS challenges the pricing of the escrow securities in an audit.
Good luck with your year-end issues, and let’s hope we’re still discussing the ins and outs of tax-exempt advance refundings next year!