Tender option, Key Takeaways
Investments in tender option bond transactions expose the Fund to counterparty risk and leverage risk. An investment in a tender option bond transaction typically will involve greater risk than an investment in a municipal fixed rate security, including the risk of loss of principal. Distributions on TOB Residuals will bear an inverse relationship to short-term municipal security interest rates.
The TOB Residuals in which the Funds will invest pay tender option or income that, in the opinion of counsel to the issuer, is exempt from regular Federal income tax. BlackRock will not conduct its own analysis of the tax status of the interest or income paid by TOB Residuals held by the Funds, but will rely on the opinion of counsel to the issuer.
Leveraging special purpose trust investments | Nuveen
Although volatile, TOB Residuals typically offer the potential for yields exceeding the yields available on fixed rate Tender option Bonds with comparable credit quality. TOB Floaters may have first priority on the cash flow from the Municipal Bonds held by the TOB Trust and are enhanced with a liquidity support arrangement from a third party Liquidity Provider defined below which allows holders to tender their position at par plus accrued interest.
A Fund that contributes the Municipal Bonds to the TOB Trust is paid the cash received by the TOB Trust from the sale of the TOB Floaters, less certain transaction costs, and typically will invest the cash to purchase additional Municipal Bonds or other investments permitted by its investment policies.
In certain cases, when Municipal Bonds transferred are lower grade Municipal Bonds, the TOB Trust transaction includes a credit enhancement feature that provides for the timely payment of principal and interest on the bonds to the TOB Trust by a credit enhancement provider.
What The Volcker Rule Means For Tender Option Bonds
The TOB Trust would be responsible for the payment of the credit enhancement fee and a Fund, as a TOB Residual holder, tender option be responsible for reimbursement of any payments of principal and interest made tender option the credit enhancement provider. TOTEs include the bankruptcy or default of the issuer of the Municipal Bonds held in the TOB Trust, a substantial downgrade in the credit quality of the issuer of the Municipal Bonds held in the TOB Trust, failure of any scheduled payment of principal or interest on the Municipal Bonds, and a judgment or ruling that interest on the Municipal Bonds is subject to federal income taxation.
If a Fund invests in a TOB Trust on a recourse basis, it will typically enter into a reimbursement agreement with the Liquidity Provider pursuant to which the Fund is required to reimburse the Liquidity Provider the amount of any Liquidation Shortfall.
Interest income from the underlying Municipal Bonds is recorded by a Fund on an accrual basis. Interest expense incurred on the TOB Floaters and other expenses related to remarketing, administration, trustee and other services to a TOB Trust are reported as expenses of a Fund.
For Tender option Floaters, generally, the interest rate earned will be based upon the market rates for Municipal Bonds with maturities or tender option provisions that are comparable in duration to the periodic interval of the tender option. Tender option the tender option feature has a shorter term than tender option final maturity or first call date of the underlying Municipal Bonds deposited in the TOB Trust, the holder of the TOB Floaters relies upon the terms of the agreement with the financial institution furnishing the liquidity facility as well as the credit strength of that institution.
The Fund reserves the right to modify its asset segregation policies in the future to the extent that such changes are in accordance with applicable regulations or interpretations.
Tender Option Bonds — Pacific Muni
The Volcker Rule precludes banking entities and their affiliates from sponsoring TOB Trusts as such Trusts have been structured prior to the effective date of the Volcker Rule. Banking entities subject to the Volcker Rule are required to fully comply by July 21,with respect to investments in and relationships with TOB Trusts that were not in place prior to December 31,and by July 21,with respect to investments in and relationships with TOB Trusts that were in place prior to December 31, As a result, TOB Trusts may need to be restructured or unwound.
In response to the restrictions imposed by the Volcker Rule, market participants have developed a new structure for TOB Trusts designed to ensure that no banking entity is sponsoring the TOB Trust for purposes of the Volcker Rule. In such a structure, certain responsibilities that previously belonged to the sponsor bank will be performed by, or on behalf of, a Fund.
Tender Option Bonds Structure
A Fund may utilize service providers in meeting these responsibilities. This structure remains untested. Under the new TOB Trust structure, a Fund will have certain additional duties tender option responsibilities, which may give rise to certain additional risks including, but not limited to, compliance, securities law and operational risks. Service providers to a TOB Trust, such as administrators, liquidity providers, trustees, and remarketing agents, would be tender option at the direction of, and as agent of, the Fund as the TOB Residual holder.
Tendered TOB Floaters would continue to be supported by a remarketing agent and a liquidity facility. However, the remarketing agent is not anticipated to purchase tendered TOB Floaters for its own account in the event of a failed remarketing, which may increase the likelihood that a TOB Trust will need to be collapsed and liquidated in order to purchase the tendered TOB Floaters.
The Liquidity Provider is not obligated to advance such a loan. The TOB Trust would be the borrower with respect to any such loan.
Qualified tender option bond entity means an issuing entity with respect to tender option bonds for which each of the following applies: i Such entity is collateralized solely by servicing assets and by municipal securities that have the same municipal issuer and the same underlying obligor or source of payment determined without regard to any third-party credit enhancementand such municipal securities are not subject to substitution. C The types of securities referred to in paragraphs ii A and B of this definition must constitute asset -backed securities. Tender option bond means a security which has features which entitle the holders to tender such bonds to the issuing entity for purchase at any time upon no more than days' notice, for a purchase price tender option to the approximate amortized cost of the security, plus accrued interest, if tender option, at the time of tender. The sponsor with respect to an issuance of tender option bonds by a qualified tender option bond entity may satisfy its risk retention requirements under this Section by holding municipal securities from the same issuance of municipal securities deposited in the qualified tender option bond entitythe face value of which retained municipal securities is equal to 5 percent of the face value of the municipal securities deposited in the qualified tender option bond entity.
However, as described above, a Fund would bear the risk of loss with respect to any Liquidation Shortfall if it holds a recourse TOB Residual. TOB Trust transactions constitute an important component of the municipal bond market. Accordingly, implementation of the Volcker Rule may adversely impact the municipal market, including through reduced demand for and liquidity of municipal bonds and increased financing costs for municipal issuers.
Any such developments could adversely affect the Funds.
Muni Bond Leverage: Risk vs. Reward of Tender Option Bonds
The ultimate impact of these rules on the TOB market and the overall municipal market is not yet certain. Certain Funds may hold tax-exempt derivatives which may be in the form of tender option bonds, participations, beneficial interests in a trust, partnership interests or other forms.
A number of different structures have been used. For example, interests in long-term fixed-rate municipal debt obligations, held by tender option trustee or custodian, are coupled with tender option, demand and other features when the tax-exempt derivatives are created. Together, these features entitle the holder of the interest to tender or put the underlying municipal debt obligation to a third party at periodic intervals and to receive the principal amount thereof.
In some cases, municipal debt obligations are represented by custodial receipts evidencing rights to receive specific future interest payments, principal payments, or both, on the underlying securities held by the custodian. Under such arrangements, the holder of the custodial receipt has the option to tender the underlying securities at their face value to the sponsor e.
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- 17 CFR § - Qualified tender option bonds. | CFR | US Law | LII / Legal Information Institute
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Trusts and partnerships are typically used to convert long-term fixed rate high quality bonds tender option a single state or municipal issuer into variable or floating rate demand instruments.
The Municipal Bond Funds may hold tax-exempt derivatives, such as participation interests and custodial receipts, for municipal debt obligations which give the holder the right to receive payment of principal subject to the conditions described above. Neither a Fund nor its investment adviser or sub-advisers will review the proceedings related to the creation of any tax-exempt derivatives or the basis for such opinions.
Shareholders should retain this Supplement for future ways to make money on the Internet without investing.
The use of leverage can increase returns as well as magnify losses. Residual Investor Exercises Call Option - Residual investors can call the Floaters for Par plus Gain Share in order to withdraw the underlying bonds upon 5 business days notice. Residual holders have the option to pay the Gain Share into the Trust in order to keep the Trust outstanding. Otherwise, the Remarketing Agent will sell the underlying bonds and dissolve the partnership. Failed Remarketing of the Floater Tender option - If the Remarketing Agent is unable to sell tendered Floaters during the notice period, typically 5 business days, the Liquidity Provider will instruct the Remarketing Agent to sell the underlying bonds and redeem the Floater and Residual certificates with bond proceeds.