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Forward Supply Contract (FSC)
The investment of the monies in debt service or revenue funds
is a valuable, but often overlooked, opportunity for bond issuers.
Utilizing a forward supply contract for permitted investments to
invest the revenue or debt service fund allows a bond issuer to
earn significantly higher yields and obtain all of the earnings
now. This program has no adverse effect on the rating or security
of the bonds.
Many revenue bond indentures and resolutions require issuers
to deposit money with their trustees prior to the disbursement
of those funds to bond holders. Monies are frequently paid each
month on the basis of one-sixth of the next interest payment and
one-twelfth of the next principal payment. These monies are often
ignored as sources of investment income for issuers. Instead of
investing the debt service or revenue fund with the trustee in
a short-term investment (as is now commonly done), the FSC enables
issuers to invest these monies at higher rates, just as if they
were long-term investments.
The FSC obligates the issuer's trustee to use the monies deposited
on a monthly basis into the debt service or revenue fund to purchase "permitted
investments" from the FSC provider. These investments mature
on or before the monies are required for debt service payments.
Consequently, there is no market risk on the value of the "permitted
investments."
The issuer may opt to receive a payment at the closing of the
FSC representing the net present value of all of the earnings on
the FSC investments or may receive those payments as interest accrues
overtime.
Earnings on these funds usually are not subject to rebate and
are not relied upon in the structuring of the financing, so the
issuer may spend this money for other purposes, including paying
costs of issuance or reducing the bond issue size. Alternatively,
a bond issuer may choose to take the interest earnings over the
life of the investment or utilize an investment agreement to increase
the yield.
Execution and Issues
The first step is to provide Winters & Co. with a debt service
schedule. Upon our receipt of the schedule, we can give you an
estimate of the value of the forward supply contract.
The credit of the issuer, certainty of the cash flows occurring
as scheduled, and financing size are items of attention for FSCs.
In general, issuers should be rated at least "BBB" and
the bond size should be at least $10 million. It may be possible
to accommodate debt service schedules that have some slight uncertainty
as to the exact timing of the receipt of funds.
If the bonds are public purpose bonds (as opposed to private
activity bonds), the money paid to the issuer by the FSC provider
is not subject to the arbitrage rebate requirements. In other words,
the issuer is able to use and keep these funds without regard to
rebate. If the bonds are private activity bonds, there are exceptions
that allow these funds to be exempt from the arbitrage rebate requirements.
FSCs do not have an adverse impact on the credit rating of the
bond issue and may be viewed as being free of any counterparty
risk since the trustee always has cash or permitted investments
that mature prior to the date on which cash is required. Should
the provider of the forward supply contract fail to deliver permitted
investments per their agreement, the trustee may invest these funds
until delivery is made.
Utilizing an FSC for the revenue fund does not inhibit the issuer's
ability to refund the bonds. If the bonds are refunded, the issuer
can choose to continue the contract with the new bond issue with
a marginal payment paid or received, based on the new bond debt
service. Alternatively, the issuer may choose to terminate the
agreement by making a termination payment. This payment amount
can be calculated by obtaining and averaging bids for replacing
the bond issuer.
Using this program is almost always more advantageous than investing
at significantly lower short-term interest rates and hoping that
rates rise dramatically. The money that is not earned while waiting
for interest rates to increase is almost impossible to recoup without
an extreme increase in interest rates. The longer the bond issuer
waits for rates to increase, the more rates must go up to overcome
the low rates encountered in the early years of the investment.
Given this, it usually makes the most financial sense to invest
long-term now, rather than waiting and hoping rates increase significantly
in the future.
- This program can be applied to new or existing deals.
- The issuer
can take cash at closing or a rate over time.
- If a forward
supply contract is used, there is no counterparty risk.
- Interest earnings on a revenue fund are usually not subject to rebate.
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