Under the payment in lieu of redemption or purchase in lieu of redemption structure,issuers purchase bonds that are callable, instead of redeeming and defeasing them. Thus,the bonds are still considered outstanding and the debt still retains the originalinsurance.
The issuer sends out a call notice to investors and offers to purchase outstanding bondsat a certain price, indicating that if they do not purchase them, the bonds may becalled at a particular date. The issuer then arranges to purchase the bonds and sellsthem to the dealer. The dealer creates a tender-option bond program and sells resultingtrust certificates to previously arranged investors. Those funds are paid to the dealer,which then pays the issuer. At that point, the issuer pays the bondholders. It's allsettled on the same day. And because the original bonds remain outstanding, it is notconsidered a re-issuance.
After the trust is created, it may hold high interest-rate fixed-rate bonds of 7%, forexample. The dealer now has the ability to issue two classes of certificates, with aright to receive payments from the underlying bonds.
One class may be a variable-rate demand obligation. The dealer may sell $95 worth offloaters to one set of investors, and the remaining $5 in principal to another set ofinvestors. The dealer then pays an interest rate of 3% on the $95 and 4% on the residualportion to its investors, which is usually the dealer itself.
After that, the dealer gives the issuer the equivalent of the payments that are paid offto the residual holders, so the hospital gets most of the balance of the 7% - or pocketsclose to 4% in savings.
As long as the weekly interest rate is lower than 7%, the issuer is a winner because thebonds are still insured and it is getting a lower rate.
The issuer gets the money not paid to the floater holders.
The dealer cannot give the issuer the residual certificate that entitles them to 4%because it creates tax issues in terms of who is the true owner of the bond and whetherthe bonds have been paid off, according to lawyers familiar with the structure. Soinstead of giving the issuer the residual certificates, the dealer keeps thecertificates and then enters into a total rate of return swap with the issuer that willgive back to the issuer close to 4%, or "most of the economics of ownership."
As long as both are separate instruments, then the issuer will not be the owner of theresidual, yet ends up with most of the economics of the deal.
Termination payments may or may not be applicable depending on the nature of thetransaction.
According to market sources, the sponsors of the largest tender-option bond programshave been most active in executing these deals. The firms primarily work alongside CainBrothers, which has been the dominant financial adviser for these types of transactions.
