Key Takeaways
- Long-term bonds with floating interest rates.
- Investor can redeem notes with short notice.
- Often backed by banks for credit safety.
- Typically tax-exempt, appealing to municipal funds.
What is Variable Rate Demand Note (VRDN)?
A Variable Rate Demand Note (VRDN) is a type of long-term municipal bond that features a floating interest rate resetting periodically, combined with a demand feature allowing investors to redeem the note at par value on short notice. This structure provides both the benefits of long-term bonds and short-term liquidity.
VRDNs typically reset interest rates based on indexes like the SIFMA index and include a put option, giving you flexibility and access to cash when needed, which can be critical in managing your obligation to meet financial goals.
Key Characteristics
VRDNs blend long-term maturity with short-term liquidity and credit features:
- Floating Interest Rate: Resets often weekly or daily based on benchmarks such as the SIFMA index, aligning yields with current market conditions.
- Demand/Put Feature: Investors can tender notes back at face value plus accrued interest, typically with 1-7 days’ notice.
- Credit Enhancements: Often supported by back-to-back letters of credit or liquidity providers to ensure payment and liquidity.
- Tax Status: Many VRDNs are federally tax-exempt, making them attractive to municipal money market funds and tax-sensitive investors.
- Long-Term Maturity: Usually issued with 20-30 year maturities but behave like short-term instruments due to the demand feature.
How It Works
VRDNs pay interest at a variable rate that resets periodically to reflect short-term market rates, often weekly based on the SIFMA index, providing investors with market-driven yields. You can tender the note back to a remarketing agent or liquidity provider at par value, typically with a short notice period of 1 to 7 days.
If the remarketing agent cannot resell the tendered notes, a liquidity provider steps in to purchase them, ensuring you maintain liquidity. This mechanism allows VRDNs to function similarly to short-term debt despite their long maturities, and understanding concepts like Macaulay duration can help assess their interest rate sensitivity.
Examples and Use Cases
VRDNs are widely used by municipalities and corporations seeking flexible financing options with liquidity protection:
- Municipal Projects: A county may issue VRDNs to finance infrastructure, relying on credit enhancements to attract investors.
- Corporate Liquidity Management: Companies like BND use VRDNs within bond portfolios to maintain liquidity and manage interest rate risk.
- Airlines: Firms such as Delta incorporate VRDNs into their capital structure to optimize short-term financing costs while securing long-term funding.
Important Considerations
While VRDNs offer liquidity and tax advantages, they carry certain risks and limitations. The demand feature can be suspended if credit ratings fall or market conditions deteriorate, potentially reducing liquidity. Additionally, reliance on liquidity providers means you assume some counterparty risk, though this is mitigated by the use of highly rated banks.
Investors should evaluate the credit quality of the issuer and the backing letters of credit or other enhancements. VRDNs can serve as a safe haven in volatile markets, but understanding their structure and market mechanisms is essential before including them in your portfolio.
Final Words
Variable Rate Demand Notes offer long-term municipal exposure with the flexibility of short-term liquidity and floating rates. Consider comparing current VRDN structures and credit enhancements to align with your income and risk preferences before investing.
Frequently Asked Questions
A VRDN is a long-term municipal bond with a floating interest rate that resets periodically and includes a put option allowing investors to sell the bond back at par value on short notice, typically between 1 to 7 days.
The interest rate on a VRDN resets based on short-term benchmarks like the SIFMA index or money market rates plus a margin, often on a daily or weekly basis, helping yields stay aligned with current market conditions.
The put option lets investors tender their notes back to a remarketing agent or liquidity provider at par value plus accrued interest, usually with 1 to 7 days’ notice, providing high liquidity and quick access to principal.
Many VRDNs come with credit and liquidity enhancements such as Letters of Credit or Standby Purchase Agreements from highly rated banks, which reduce issuer credit risk and enhance safety for investors.
VRDNs are often federally tax-exempt and offer high liquidity due to the put feature, making them attractive for municipal money market funds that seek tax efficiency and short-term access to funds.
Remarketing agents reset interest rates to attract buyers and handle the resale of tendered notes. If resales are unsuccessful, a liquidity provider typically steps in to purchase the notes, maintaining liquidity.
VRDNs offer high liquidity, protection against rising interest rates through floating rates, competitive yields linked to short-term markets, strong credit quality due to enhancements, and tax-exempt income.
