3.4.2.2 Tender or Demand Obligations

Tender or demand obligations (referred to as “variable-rate demand obligations” or “VRDOs”) are long term obligations that achieve short term interest rates by offering a “tender” or “put” feature. Bonds may be tendered (delivered to the issuer or its agent for purchase) or may be subject to a mandatory tender when certain events occur before maturity. The intervals at which the holder can tender bonds for purchase can vary (daily, quarterly, or twice per year) but a right of a holder to tender on any business day upon providing 7 days’ notice (obligations known as “weekly floaters”) is the most common variable interest rate “mode.” A tender can be occasioned by the following:

An optional tender by the holder and demand for purchase by the issuer
An election by the issuer (such as an interest rate mode conversion)
The occurrence of a specified event (such as the expiration of a credit support or liquidity facility or a tender resulting from an issuer default under a credit agreement)
A specified date or at specified intervals

The interest rate following the tender of obligations tendered in whole is generally the rate at which the securities can be remarketed at par. The interest rate on obligations subject to optional tender is generally the interest rate that the remarketing agent, in its professional judgment, determines to be the rate at which the securities could be remarketed at par, even if no obligations have been tendered. The interest rate on obligations subject to tender by the holders on 7 days’ notice is generally reset weekly. Issuers of tender bonds must engage a broker dealer firm to act as the remarketing agent for purposes of establishing the interest rate and remarketing tendered bonds and because the purchasers of variable rate demand obligations require a high degree of certainty that purchase obligations upon tender will be honored, issuers that do not have very strong credit must obtain liquidity support for the purchase of obligations tendered and not remarketed and credit support for the debt. See Section 2.3.2, Credit Enhancement and Liquidity Support.

REMARKETING AND PURCHASE – Tendered bonds are remarketed by the remarketing agent at the interest rate (subject up to a maximum rate) that enables the remarketing agent to sell the bonds to new investors at par. If all the bonds of a series are remarketed, the remarketing may be “underwritten,” meaning that the remarketing agent agrees to purchase the bonds whether or not it has identified new purchasers. Generally, however, and always in the case of VRDOs tendered by the holders, the remarketing agent’s obligation to remarket the bonds is a “best efforts” undertaking.

If the remarketing agent is unable to remarket tendered bonds, the bonds are generally purchased by the issuer’s liquidity provider or are purchased for the account of the issuer with the proceeds of a draw on a line of credit or letter of credit, in which case the issuer has a payment or reimbursement obligation to the purchaser. Bonds held by a liquidity provider, or reimbursement obligations resulting from draws on liquidity facilities, generally bear interest at relatively high rates and the issuer may be obligated to pay principal more rapidly than the scheduled principal on the purchased bonds. When conditions allow, tendered bonds that are not remarketed and purchased by the liquidity provider or credit provider may be remarketed to new investors in the future. See Section 2.3.2, Credit Enhancement and Liquidity Support.

FLOATING-RATE NOTES – Floating-rate notes are obligations (which can be bonds) that bear interest at an index rate but are subject to mandatory tender for purchase on a future date, generally between 2 and 4 years from the offering date. The notes are usually also subject to tender at the option of the issuer for a 6 month window before the mandatory tender date. Because payment of the purchase price on the tender date is dependent upon the issuer’s ability to refund or remarket the notes (including remarketing for a new floating-rate note period), floating rate notes may only be issued by public agencies with strong credit ratings and reasonably assured market access.

AUCTION-RATE SECURITIES – With auction rate securities (ARS), debt holders may offer to sell their holdings on periodically scheduled auction dates at interest rates they specify to prospective purchasers, who offer to buy the securities at interest rates they specify. The interest rate from that auction date to the next auction date is the rate that “clears the market,” that is, the rate at which the aggregate dollar amount of sell orders matches the aggregate dollar amount of buy orders. The issuer of the debt has no obligation to purchase bonds offered for sale, so no liquidity support is needed. Auction-rate securities were common in the municipal market until the auction market failed to function during the financial crisis of 2008.

INTEREST RATE MODE CONVERSION – Debt documents generally allow an issuer of variable rate debt to elect to convert the tender and interest rate period from one mode to another (e.g., from weekly to twice per year, or from daily to weekly) or to fix the rate interest on the debt to its maturity. An interest rate mode conversion may be more efficient than a refunding and may be possible even if a change in law would make a refunding impractical, either because of a change in tax law or new state law limitations. The debt securities are generally subject to mandatory tender for purchase on the mode conversion date and then to be remarketed in the new mode.

DOCUMENTATION – The indentures, trust agreements, and leases providing for variable rate debt must address interest rate determination methods, tender rights and requirements, and the remarketing of tendered bonds and are therefore more complex than fixed rate debt documents. Further documentation is also required if a liquidity or credit support facility is needed. See Section 2.3.2, Credit Enhancement and Liquidity Support. A remarketing agreement between the issuer and a remarketing agent is necessary to specify the rights, duties, and compensation of the broker dealer engaged to determine interest rates and remarket tendered bonds.