INFORMATION CONCERING VARIABLE RATE DEMAND OBLIGATIONS
Piper Jaffray underwrites and acts as a Remarketing Agent on many issues of variable rate demand obligations (VRDO). VRDO are a financing tool that allow issuers to borrow money over longer terms at interest rates tied to the short term market. Short term interest rates have been historically below long term rates and issuers are able to recognize meaningful interest rate savings from using this financing tool. Interest rates on VRDO are variable and reset by a Remarketing Agent at periodic intervals, typically on a weekly, daily, monthly or quarterly basis. This document explains some of the basic features of VRDO.
The description of VRDO contained herein is general and summary in nature and should not be considered definitive or relied upon with respect to any particular issue of VRDO. As to any particular issue of VRDO, the information contained herein is qualified in its entirety by reference to the official statement, indenture, credit or the liquidity provider documents such as the letter of credit, the standby bond purchase agreement and other governing documents with respect to such issue. Investors and others should rely only on the governing documents as to the terms and conditions of particular issues of VRDO.
VRDO give holders the right to tender bonds, on notice to a trustee or tender agent, at par plus accrued interest. A Remarketing Agent, such as Piper Jaffray, agrees to use its best efforts to remarket the tendered bonds. If the VRDO are not remarketed to another investor, they are purchased from the tendering holder through a trustee by a credit or liquidity provider at par plus accrued interest. From time to time, a Remarketing Agent, at its sole discretion, may facilitate liquidity by offering to purchase the bonds directly from investors and selling the bonds to other investors. The Remarketing Agent may also, at its sole discretion, provide secondary market liquidity for VRDO at prices other than par. In either case, however, the Remarketing Agent has no legal obligation to purchase or otherwise provide liquidity for VRDO. The Remarketing Agent’s historical willingness to purchase or otherwise provide liquidity for VRDO should not be construed as assurance that the Remarketing Agent will continue to do so in the future.
VRDO generally are designed with one of two types of liquidity support for the tender right of the VRDO holder: a letter of credit (LOC) or a standby bond purchase agreement (SBPA), in either case provided by a bank or other qualified financial institution (Liquidity Provider). Sometimes an issuer or borrower will provide liquidity support for VRDO, these situations are not discussed here and investors should reference the underlying documents for an understanding of these provisions. Under a typical LOC, the Liquidity Provider provides liquidity respecting a tender by the holder but also pays principal of and interest on the bonds, either directly to investors through a trustee, as in a direct-pay LOC, or in a backup arrangement in the event the issuer or obligor fails to pay. These draws on the LOC are reimbursed to the Liquidity Provider through a reimbursement agreement between the Liquidity Provider and the issuer or obligor.
SBPA are very different. Under a typical SBPA, the Liquidity Provider provides liquidity for tenders by the holders if the VRDO cannot be remarketed, but does not pay principal of or interest on the VRDO. In addition, under a typical SBPA, the Liquidity Provider may have the right to terminate the liquidity support under certain conditions, discussed below. Sometimes where an SBPA is provided, obligors also will secure their bonds with a municipal bond insurance policy to further enhance the long-term rating on the VRDO.
Although banks are the typical liquidity providers, VRDO are not insured by the FDIC. VRDO are considered short term investments because the tender right and interest rates are based on short time horizons (except under certain circumstances described below) but VRDO are not cash equivalents, money market funds or deposit accounts of a bank. VRDO are subject to:
- the risk of default by the Liquidity Provider, bond insurer or obligor, as applicable
- the effect of rating downgrades on any or all of the Liquidity Provider, bond insurer or obligor, as applicable, which may affect liquidity and the market value of the VRDO, and
- with respect to SBPAs, the occurrence of termination events, in some circumstances without prior notice to holders or a mandatory purchase of the VRDO from the holder.
Investors may have limited or no remedies against the obligor of the VRDO for the loss of their tender rights. Investors should look carefully at the financial strength of the Liquidity Provider as the security for their tender rights in considering whether to invest in VRDO. Obligors or issuers are responsible for obtaining LOCs and SBPAs and to obtain substitute or replacement Liquidity Providers as required by the governing documents. Piper Jaffray as Remarketing Agent assumes no responsibility in this respect. Interest rates on VRDO are typically capped, either under state law or by contract, to protect the obligor from excessive interest rate risk. If the prevailing market interest rate is higher than the capped rate, investors may not be able to realize market rates.
Additional Information Respecting Credit Available Ratings on Request
For information concerning the credit rating of a VRDO, the underlying credit rating of the issuer or obligor and the identity of the credit enhancer or liquidity provider, including potential rating actions, contact your Piper Jaffray representative.
Special Considerations Respecting VRDO Supported by Standby Bond Purchase Agreements
If a holder owns a VRDO backed by an SBPA, under normal circumstances the holder may tender the VRDO to a trustee on notice for purchase at the par value of the VRDO. In the ordinary course, the VRDO is remarketed to new investors by the Remarketing Agent and the remarketing proceeds are used to pay the tendering owner the purchase price of the tendered VRDO. If the Remarketing Agent is unable to successfully remarket the VRDO, the trustee will draw under the SBPA to fund the payment to the tendering owner of the purchase price of the tendered VRDO. However, the occurrence of one or more events could give the Liquidity Provider under an SBPA the immediate right to terminate or suspend its obligation to purchase a VRDO without notice to the holder and without the occurrence of a mandatory purchase of the VRDO from the holder. Please review the official statement or offering documents for information specific to your VRDO. Official statements are usually available on the MSRB’s website at http://www.emma.msrb.org
If an SBPA terminates or is suspended, the holder would lose the right to sell the VRDO before the nominal maturity date for the VRDO. Generally, none of the Remarketing Agent, the issuer or any obligor would typically be expected to intervene and supply funds to purchase tendered VRDO in these circumstances. In some cases the duties of the Remarketing Agent to continue to remarket the VRDO may be terminated or suspended. As a practical matter, the VRDO effectively would be converted from a short term investment with a tender right to the equivalent of a long term bond for which there may be no liquidity, depending on market conditions. In addition, no assurances can be provided respecting the interest rate applicable to these VRDO. Interest rates on VRDO are typically capped, and in the case of a termination of the SBPA, rates may be indexed to a market index. In either case, the investor may not receive a prevailing market rate if the prevailing market rate is greater than the capped rate, which may adversely affect the liquidity and market value of the VRDO.
OTHER CONSIDERATIONS RELATING TO THE REMARKETING OF VRDO
Role of the Remarketing Agent
The Remarketing Agent typically agrees to set the interest rates on the VRDO, to use its best efforts to remarket tendered VRDO and otherwise to perform the other duties as Remarketing Agent provided for in the governing documents respecting the VRDO, subject to the provisions of a Remarketing Agreement between the Remarketing Agent and the issuer or obligor. The Remarketing Agent may deal in the VRDO for its own account or as broker or agent for others and may do anything any other owner may do to the same extent as if the Remarketing Agent were not serving as such.
The Remarketing Agent is Paid by the Issuer or Obligor
The Remarketing Agent's responsibilities include determining the interest rate from time to time and using best efforts to remarket VRDO tendered pursuant to the optional or mandatory tender provisions of the VRDO by the owners thereof (subject, in each case, to the terms of the Remarketing Agreement). The Remarketing Agent is appointed by the issuer or obligor and is paid by the same for its services. As a result, the interests of the Remarketing Agent may differ from those of existing holders and potential purchasers of the VRDO.
The Remarketing Agent Routinely Purchases VRDO for its Own Account
The Remarketing Agent acts as remarketing agent for a variety of VRDO and, in its sole discretion, routinely purchases such obligations for its own account. The Remarketing Agent is permitted, but not obligated, to purchase tendered VRDO for its own account and, in its sole discretion, routinely acquires such tendered VRDO in order to achieve a successful remarketing of the VRDO (i.e., because there otherwise are not enough buyers to purchase the VRDO) or for other reasons. However, the Remarketing Agent is not obligated to purchase VRDO, and may cease doing so at any time without notice. The Remarketing Agent may also make a market in the VRDO by routinely purchasing and selling VRDO other than in connection with an optional or mandatory tender and remarketing. Such purchases and sales may be at or below par. However, the Remarketing Agent is not required to make a market in the VRDO. The Remarketing Agent may also sell any VRDO it has purchased to one or more affiliated investment vehicles for collective ownership or enter into derivative arrangements with affiliates or others in order to reduce its exposure to the VRDO. The purchase of VRDO by the Remarketing Agent may create the appearance of greater demand for the VRDO in the market than would otherwise be the case without the participation of the Remarketing Agent. The practices described above also may result in fewer VRDO being tendered in a remarketing.
VRDO May be Offered at Different Prices on Any Date Including an Interest Rate Determination Date
Pursuant to the Remarketing Agreement, the Remarketing Agent typically agrees to use its best efforts to determine the applicable rate of interest that, in its judgment, is the lowest rate that would permit the sale of the VRDO bearing interest at the applicable interest rate at par plus accrued interest, if any, on and as of the applicable interest rate determination date. The interest rate will reflect, among other factors, the level of market demand for the VRDO (including whether the Remarketing Agent is willing to purchase VRDO for its own account). There may or may not be VRDO tendered and remarketed on an interest rate determination date, the Remarketing Agent may or may not be able to remarket any VRDO tendered for purchase on such date at par, and the Remarketing Agent may sell VRDO at varying prices to different investors on such date or any other date. The Remarketing Agent is not obligated to advise purchasers in a remarketing if it does not have third party buyers for all of the VRDO at the remarketing price. In the event the Remarketing Agent owns any VRDO for its own account, it may, in its sole discretion in a secondary market transaction outside the tender process, offer VRDO on any date, including the interest rate determination date, at a discount to par to some investors.
The Ability to Sell the Bonds other than through Tender Process May Be Limited
The Remarketing Agent may buy and sell VRDO other than through the tender process. However, it is not obligated to do so and may cease doing so at any time without notice and may require holders that wish to tender VRDO to do so through the trustee with appropriate notice as described in the governing documents. Investors who purchase the VRDO, whether in a remarketing or otherwise, should not assume that they will be able to sell their VRDO other than by tendering the VRDO to the trustee in accordance with the tender process as described in the governing documents. The Remarketing Agent assumes no responsibility for the performance of the trustee or any other party in discharging its duties respecting the tender process under the governing documents.
Under Certain Circumstances, the Remarketing Agent May be Removed, Resign or Cease Remarketing the VRDO, Without a Successor Being Named
Under certain circumstances the Remarketing Agent may be removed or have the ability to resign or cease its remarketing efforts, without a successor having been named, subject to the terms of the governing documents and the Remarketing Agreement.