Despite a very difficult market, SCS generated lower pricing spreads than prior District transactions with better market environments
In November 2017, Siebert Cisneros Shank served the San Diego Unified School District for its fourth senior-managed transaction for the District since 2015. Unlike the previous three transactions, this transaction came during a monumental shift in the municipal bond market’s dynamics with the pending tax reform overhaul. One component of the tax reform in particular, the elimination of tax-exempt advance refundings, caused many issuers to expedite refunding transactions before year end. This influx of supply then caused pricing spreads to increase across the board. Despite the shifting tone in the market, SCS used its experience in marketing and selling the District’s bonds to generate lower pricing spreads than in prior District transactions during better market environments.
As the week of pricing approached, the status of tax-exempt refundings became clearer by the day with both the House of Representative and Senate’s respective tax reform proposals excluding tax-exempt advance refundings. The week of pricing, the national calendar rose to $9.32 billion in bonds coming to market with the following week projected at over $17 billion. What was once an issuer’s market in September and October became a buyer’s market due to the historically large supply. Offsetting this trend in higher pricing spreads in the general market environment, was the District’s stellar credit and its track record managing its Proposition S and Proposition Z bond issuance programs.
Aside from the District’s efforts in spearheading the Fitch triple-A, demonstrating the bankruptcy-remote nature of the voter approved ad valorem tax backing, the tax rate reserve also showed the District’s proactive approach to its debt management program. Through the tax rate reserve for its combined Prop. MM/Prop. S programs, the District was able to use funds that exceeded the maximum amount of $50 million to defease outstanding debt to lower debt service cost. The transaction was rated Aa2/NR/AAA and the Series K-1 Bonds were structured as current interest bonds (“CIBs”) from 2018 to 2019 while the Series K-2 Bonds were structured as capital appreciation bonds (“CABs”) from 2029 to 2042. The overall structure of this transaction was to generate a proportional aggregate debt service of the Prop. MM/Prop. S programs versus projected AV tax revenue collections and maximizing the available debt service in 2018 to 2019 to lower debt service cost. One potential concern for this structure was the limitation on the amount of excess premium that could be generated. SCS’s underwriter felt that a 3% coupon in the 2018 maturity and a 5% coupon in the 2019 maturity would best generate enough premium to pay cost of issuance and have the excess premium stay within the maximum limit.
On the day of pricing, the municipal bond market continued to fade as the supply was so large. In a buyer’s market, SCS’s underwriter recommended that the pricing spreads from the pre-marketing be kept the same with the goal to first, build a solid book of orders, and then decrease pricing spreads as needed. As the order period opened up, orders trickled in and several maturities were oversubscribed within 30 minutes. At the end of the order period, every maturity was oversubscribed. With this successful order period, SCS’s underwriter recommended pricing spread decreases of 2 to 4 basis points for the CABs and 4 basis points for the 2018 CIBs. As a result of the pricing adjustments, the Series K-1 CIBs were now priced 1 to 2 basis points lower than the District’s Prop. Z Series H-2 Bonds priced during a favorable seller’s market in October 2017. As for the CABs, the Series K-2 Bonds priced 15 to 18 basis points lower than the Prop. S Series I CABs.