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Structuring Tender Option Bonds
A tender option bond is a synthetic derivative involving several parties. The sponsor or the underwriter deposits a tax-exempt bond with a custodian or trustee. The tender fee arrangement requires an agreement, with the sponsor and underwriter as "put provider" or "tender option provider." In most cases, a liquidity bank or a letter of credit bank is involved. Under this agreement, the put provider agrees to purchase, at predetermined times, the investors' interests in the underlying bonds at par, in return for periodically receiving a tender fee which is set through a remarketing mechanism. The amount of the fee is generally equal to the difference between the long-term coupon rate on the underlying bonds (the fixed rate) and a predetermined short-term rate. Investors are entitled to receive interest payments on the deposited bonds after deduction of various fees, including the tender fee.
The investors' ability to "put" the tender option bond may be eliminated upon the occurrence of certain events of default, which could include a:
- Determination that the underlying bonds are taxable.
- Default by the issuer of the deposited bond on payments of principal or interest.
- Significant downgrade in the credit rating of the underlying bond.
Certain tender option bond programs also permit investors to relinquish their put and obtain direct ownership of the underlying bond, usually upon payment of a predetermined termination fee. Certain tender provisions permit the period between tender dates or rate reset dates to be changed at the discretion of the remarketing agent.
SS&C's municipal finance debt structuring software, DBC Finance, makes it easy to set up specific types of tender bonds. Modeling the cost of a liquidity facility or letter of credit is easy to do. For example, the bond component created is labeled "TOB" and a typical line of credit expense would be as shown below:
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This article first appeared in the 5/9/2003 edition of our Municipal Finance eBriefing.
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- Richard Shalowitz
646-213-7103
rshalowi@sscinc.com
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