Important Information About Variable Rate Demand Notes
(Also Known As Put Bonds Or Seven-Day Floaters)
Download PDF Version: Variable Rate Demand Note Disclosure
Baird underwrites and serves as remarketing agent on offerings of variable rate demand notes(“VRDNs”), otherwise known as “put bonds” or “seven-day floaters.” This document explains the basic features of put bonds.
VRDNs are issued in a public offering or private placement by a corporate borrower, a municipality or a conduit agency which then lends the proceeds to a borrower. A prospectus, official statement or offering memorandum is prepared and delivered to purchasers in the offering, and is available to subsequent investors upon request. The VRDNs are issued under an indenture of trust in which a trustee is appointed to serve as registrar, paying agent and transfer agent and to provide other administrative services. As underwriter for the offering, Baird agrees to buy the VRDNs from the issuer at a discount from par value and sells them to clients at par. Baird also determines the interest rate on the VRDN.
The interest rate on the VRDNs is re-set on a weekly basis by Baird in its capacity as remarketing agent based on prevailing market conditions (taking into account applicable short-term interest rates). The intent is to set the interest rate so that the notes trade at par. VRDNs generally have long-term maturities but may be tendered for redemption at any time upon seven days’ notice by the holder, thus giving them short-term fixed income characteristics. Additionally, as remarketing agent, Baird engages in best efforts to solicit investors to purchase VRDNs that holders want to sell or redeem. Baird may also act as principal in purchasing VRDNs from holders but is under no obligation to do so. VRDNs may also be redeemed at par, at the option of the borrower, which may be exercised at any time.
VRDNs are usually backed by a letter of credit provided by a bank. However, VRDNs are not insured by the FDIC, are not money market funds and are not deposit accounts of a bank. Payment of interest and principal to holders is accomplished via a draw upon the bank’s letter of credit (referred to as a “direct pay” letter of credit). With this “direct pay” structure, holders do not receive payments from the borrower or issuer, but, as noted above, all payments come to holders from a draw upon the letter of credit. Through a reimbursement agreement with the borrower, the bank is reimbursed for amounts drawn on the letter of credit. By this process, the borrower “reimburses” the bank for any interest and principal payments that the bank makes on the borrower’s behalf and holders are insulated from having to collect interest and principal payments from borrowers or issuers. The failure or inability of the borrower to repay the bank does not affect the bank’s obligation to honor the terms of the letter of credit.
Borrowers normally have the right to replace the bank issuing the letter of credit with another bank. This action generally triggers a mandatory tender of the VRDNs. Once the tender occurs, the VRDNs will be remarketed to new investors with backing from the new letter of credit provider. Letters of credit remain in effect for a period of time determined by the borrower/issuer and the bank. If the issuing bank does not renew or extend the letter of credit, the borrower must obtain a letter of credit from another bank. If the borrower cannot find another bank to provide a new letter of credit, the VRDNs will be subject to a mandatory tender, with a draw upon the existing letter of credit to pay off the holders.
VRDNs are not secured by the assets of the conduit issuer (often a municipality). As a result, VRDNs are subject to the risk of default by the bank providing the letter of credit. Investors do not have any remedies against the conduit issuer and may only have limited remedies against the borrower should the bank fail to meet its obligations under the letter of credit. Investors should look to the financial strength of the bank issuing the letter of credit backing the VRDNs and other indications of the bank’s credit quality in considering whether to invest in VRDNs. The payment of interest and repayment of principal on a VRDN depend upon the ability of the bank to honor its obligations under the letter of credit supporting the VRDN, and no assurance can be given in this regard. Baird is not under any obligation to review the creditworthiness of banks that provide letters of credit underlying the VRDNs for which Baird serves as underwriter or remarketing agent. In some instances, however, Baird may request borrowers to obtain enhancements or take other actions to provide adequate support, so that the VRDNs remain marketable, but ultimately the borrowers are responsible for taking the necessary action.
For more information on VRDNs, please contact your Baird Financial Advisor.