Preston Hollow Community Capital plans an inaugural public offering of tax-exempt pooled securities that recycles a portion of its portfolio to raise capital from a new investor base for its social lending business.  

PHCC, which is part of Preston Hollow Capital LLC, plans to offer $371.5 million of tax-exempt pooled securities — or TEPS, which are a financing trust secured by a collateral pool of tax-exempt bonds — in two tranches.

The $237.5 million Class A social impact certificates carry a provisional rating of Aa1 from Moody’s Investors Service and the $134 million subordinate B tranche is unrated. The A tranche will provide funds for the firm to originate deals. Preston Hollow will purchase the B certificates.

While the public offering of TEPS is a first for the lender, it’s an evolution of a debt instrument the firm has used in 10 private unrated transactions with banks over the last five years.

The collateralized debt obligation structure may be one of the first for the market since the 2008 financial crisis when the market soured on mortgage-backed CDO structures after the collapse of the subprime market.

The goal is twofold — to achieve a lower cost of capital and to expand the firm’s investor base.

“We will use the money we raise in this offering to fund our social impact finance origination business,” said Charlie Visconsi, co-head of originations at the Dallas-based lender. “This transaction provides us with an efficient cost of capital and access to investors who want this type of investment. Historically we have accessed the bank market through term-matched trusts, or TMTs.”

“Over the last five years we have done a dozen TMT transactions, generating nearly $600 million of A certificates with over $800 million of assets deposited into trusts. With this rated, public TEPS offering we hope to reach a broader market than we would by continuing to focus exclusively on the bank market,” Visconsi said.

The timing is fluid, with negotiations ongoing with underwriters and potential investors. PHCC originally targeted last week in its investor roadshow presentation that posted on March 13th, just as the banking crisis was unfolding. The collapse of Silicon Valley Bank and Signature Bank of New York have roiled the municipal and other markets, which have seen day-to-day volatility.  

Bloomberg had cited sources in reporting last week that the underwriters “shelved” the deal.

“We have not shelved or pulled the deal,” Greg May, a managing director of corporate development, said.

“We are focused on good execution and are not in a hurry. The current market is volatile, making it a challenge for potential investors to focus on a new product from a new borrower,” Visconsi said. “We want to get in front of the right investors, and we need stable markets for good execution.”

The firm intends to regularly return to the market with TEPS — possibly several times a year — so it is building a market for the product and is aiming to establish a base with the inaugural transaction. 

The A tranche will be remarketed in 2029 and carries a final maturity in 2059. The B tranche won’t be remarketed. Preston Hollow Community Capital is the sponsor and administrator. The Public Finance Authority — a national conduit based in Wisconsin — is serving as the issuer. Wells Fargo is the senior manager and HilltopSecurities is the co-manager. Kutak Rock LLP serves as legal counsel to PHCC.

The pooled securities come from 18 municipal bond transactions — most of which were originated by PHC — from 10 states and cover a variety of sectors including special assessment, student housing, kindergarten through 12th grade public education, private higher education, skilled nursing, not-for-profit hospital, hotel, federal qualified health clinic and property tax increment. None are publicly rated.

Debt service payments from the underlying bonds in the pool will pay principal and interest on the Class A certificates. Preston Hollow is the purchaser of the B certificates and under the subordinated structures takes the first losses. That means the trust would have to suffer $133 million in losses, or 36%, before the A buyers are hit.  

The bonds are being marketed to traditional tax-exempt institutional investors. The offering documents lay out the risks. “The certificates are complex instruments that should be considered only by potential purchasers, who, either alone or with financial, tax, and legal advisors, have the expertise to analyze prepayment, reinvestment, default, and market risks,” reads the documents.

“The rationale for the rating is based on our methodology and considers all relevant risks, particularly those associated with the transaction’s portfolio and structure,” Moody’s said. “Moody’s analyzed the credit quality of the underlying bonds by developing credit estimates. In addition to the credit quality of the underlying bonds, Moody’s also considered the structural and legal aspects of the transaction in arriving at its rating.”

PHCC attached a “social” bond label to the certificates based on a second-party opinion from Institutional Shareholders Services that $309 million complies with PHCC’s social impact finance framework having financed projects related to education, healthcare services that serve vulnerable populations, affordable sanitation and sewer services, or employment opportunities.

Bonds in the portfolio also comply with the United Nations sustainable development goals.

ISS had previously provided an opinion that PHCC’s social impact finance framework aligns with the core principles of the International Capital Market Association’s Social Bond Principles.

“It is aimed at the investor base — social impact matters a lot to some investors, so the metrics and independent third-party review highlight the relevant criteria for the pool,” May said.

Preston Hollow reports in the offering documents that it’s raised $1.2 billion in equity capital from sources including Stone Point Capital, which has a 25% beneficial ownership in Preston Hollow and HarbourVest Partners, which has a 33.5% stake. PHCC LLC has a portfolio of approximately $2.5 billion of loans provided in 25 states and the District of Columbia as of Dec. 31, 2022.

The transaction does not permit asset purchases or substitutions; the portfolio will be fully ramped at closing; and the transaction does not permit additional purchases or substitutions of assets after closing unless certain conditions are satisfied, and there are restrictions on modifying bond maturity. Moody’s described those factors as credit strengths.

Challenges stems from a concentrated portfolio of issuers, defaulted assets are carried at market value for over-collateralization purposes and the treatment of defaulted assets in OC calculations.