Overview of Multi-Modal Debt Financing Instruments
1. Multi-modal bond instruments have evolved in the municipal market to allow tax-exempt issuers the ability to access capital in both a variable rate and fixed rate mode.
2. A variable rate bond can be issued in two formats:
- A variable rate demand bond, is supported not only by the credit of the borrower and their insurance, but also by a “liquidity facility” or letter of credit (LOC) which is a stand-by bond purchase agreement from a commercial bank.
· With these instruments, the investors have the right to “put” the bond back to the borrower (via the trustee) each time the interest rate is reset (usually either every day or every week), and that is why there is the need for a “guarantee” in the form of an LOC.
· It is the responsibility of the “remarketing agent” (typically the lead underwriter) to remarket the bonds each time the rate is reset, and to remarket the bonds in the event that the current investor puts the bonds back to the borrower.
· The cost of issuance and underwriting fees for this type of instrument are similar to those for a fixed rate issue, but with an additional origination fee for the LOC, and on-going (relatively minor) remarketing fees.
- An auction rate bond issue is also managed by a remarketing agent.
· With this type of instrument, the remarketing (or auction) agent solicits bids from investors on a periodic basis (usually every 28 or 35 days).
· This instrument does not offer investors the right to “put” bonds back to the borrower, so there is no requirement for an LOC.
· For this instrument, the remarketing agent fees are more than that for variable rate demand bonds; but, there are no LOC fees. So, the “All In” interest rate cost for auction rate bonds is usually less than that for LOC-backed issues.
· Auction rate bond issues are regularly used by government entities throughout the nation. A.G. Edwards currently has a “book” of over $4 billion auction rate bonds. Citigroup has a book of over $40 billion, and Merrill Lynch, UBS Paine Webber, Bear Stearns, and Lehman Brothers have auction rate books in the range of $10 to $30 billion each.
3. Overall, the variety of debt offerings that are possible under a multi-modal issue include the following:
- Commercial Paper: with a variable rate reset every 1 – 270 days, and requiring an LOC.
- Weekly Rate: with a variable rate reset every 7 days, and requiring an LOC.
- Flexible Rate: with a variable rate reset every 365+ days, typically on a 1 – 2 year basis, and requiring an LOC.
- Auction Rate: with a variable rate reset every 7, 28 or 35 days, with no LOC required.
- Fixed Rate: which provides a one-time option for the issuer to fix the rate for the remaining duration of the loan, with no LOC required.
4. Montana State University’s plan, under this proposal, is to utilize auction rate bonds, with a 35-day remarketing term.
c:Sept Bond Item – Att 1.doc