Variable Rate Demand Note (VRDN)

Variable Rate Demand Note (VRDN)

Key takeaways
* A VRDN (also called a VRDO) is a long-term municipal debt instrument with a floating interest rate and a demand (put) feature.
* Interest resets to a prevailing short-term money-market rate (daily, weekly, or monthly) plus a spread.
* VRDNs are typically issued in large denominations (commonly $100,000+), so most retail investors access them indirectly through money-market or municipal bond funds.
* VRDN liquidity and creditworthiness are usually supported by a bank-provided liquidity facility or letter of credit, which influences short-term credit risk.

What is a VRDN?
A Variable Rate Demand Note (VRDN) is a municipal bond that combines long-term financing for the issuer with short-term interest-rate treatment for investors. The coupon rate resets regularly based on a reference money-market rate (for example, a spread over the bank prime or other short-term benchmark). Holders have the right to demand repayment at each put date.

How VRDNs work
* Interest rate: Resets at specified intervals (commonly daily, weekly, or monthly) to a money-market benchmark plus a negotiated margin.
* Put (demand) feature: Investors can tender the note back at a scheduled put date (often with 1- or 7-day notice). Because of this feature, the effective maturity for investors is the next put date rather than the long-term final maturity.
* Remarketing: When an investor tenders their note, a remarketing agent attempts to sell it to another investor at the current rate. If remarketing fails, the issue is covered by a predetermined liquidity facility or purchased by a designated institution.

Key characteristics
* Denominations: Typically sold in large blocks (frequently $100,000 or more), which limits direct retail access.
* Credit enhancement: VRDNs are commonly supported by letters of credit (LOCs) or standby bond purchase agreements from highly rated banks. These facilities provide liquidity and timely payment if remarketing fails.
* Short-term credit linkage: Because the LOC or liquidity provider backs the tender/repayment obligation, the effective short-term credit risk (and yield) often reflects the liquidity provider’s rating rather than the issuing municipality’s long-term rating.
* Market role: VRDNs are a core holding for institutional money-market funds and other cash-management vehicles.

Tax treatment
* Interest from most VRDNs issued by municipalities is exempt from federal income tax.
* Some VRDNs may also be exempt from state and local taxes in the state of issuance. Tax treatment depends on the specific issue and applicable tax rules.

Who can invest
* Direct purchase typically requires large minimum investments, so most individual investors gain exposure via:
* Money-market funds that invest in VRDNs
* Municipal bond mutual funds or ETFs that include VRDOs
* Institutional investors and cash managers are the primary direct buyers.

Redemption and remarketing mechanics
* Put feature: Investors can demand payment at scheduled put dates. Notice requirements are usually short (e.g., 1–7 days).
* Remarketing agent: Attempts to resell tendered notes to new investors at the prevailing rate.
* Failed remarketing: If no buyer is found, a liquidity facility typically steps in to purchase the securities, or a designated bank buys them under a standby agreement. These arrangements are intended to protect holders and maintain liquidity.

Benefits and risks
Benefits
* Liquidity: Short put intervals and liquidity facilities make VRDNs a liquid cash-management tool.
* Interest-rate responsiveness: Frequent resets protect holders from long-term rate lock-in when short rates rise.
* Tax advantages: Typically exempt from federal (and sometimes state) income tax.
* Diversification: Low correlation with common equity and long-duration bond returns.

Risks
* Counterparty risk: The liquidity provider or letter-of-credit issuer is a critical counterparty; its solvency affects liquidity and repayment confidence.
* Remarketing risk: If remarketing fails and the liquidity facility is impaired, holders could face delays or losses.
* Minimum denomination: High minimums limit direct access for retail investors.
* Short-term credit exposure: Yield and perceived safety reflect the short-term credit quality of supporting banks rather than the long-term credit of the municipality.

Conclusion
VRDNs allow municipalities to borrow long term while offering investors short-term, tax-advantaged, and liquid cash-like instruments—particularly useful for institutional cash management. Retail investors typically access VRDN exposure through money-market or municipal bond funds. The instruments’ safety and liquidity depend heavily on credit enhancement and the strength of the liquidity provider.