WASHINGTON — Merrill Lynch, Pierce, Fenner & Smith on Thursday sold the first tender option bonds structured to comply with the Volcker Rule, a feat Moody's Investors Service said will benefit the market by allowing TOB trusts to continue purchasing munis.
Merrill Lynch's $8.5 million sale relies on the joint venture exemption from the Volcker Rule, which prevents banks and their affiliates from sponsoring a TOB program, owning a residual certificate issued by a TOB trust, or providing credit enhancement, liquidity, or remarketing services to these programs.
In a typical TOB program, the sponsor will deposit a fixed-rate bond or note into a trust, which will issue two new certificates — a floating rate certificate sold to a money market fund and a residual certificate which may be sold to a mutual or closed-end fund or held by a bank. The floating rate certificate will have a tender option, through a liquidity facility that is typically issued by the program's sponsor or an affiliate, that shortens the maturity of the bond or note so it becomes eligible to be purchased by a tax-exempt money market fund.
Unlike a typical TOB where Merrill Lynch would have acted as the issuer of the TOB trust, Merrill Lynch sold the bonds to a joint venture trust with US Bank, which was acting as the trustee. The investors, known as "venturers" under the new structure, are to be determined. Joint ventures among 10 or fewer participants are exempt from Volcker.
On EMMA, the issuer's name is JVI TR RCPTS and its CUSIP identifier is 46641N.
The $70-$80 billion TOB market has been wrestling with potential solutions to the Volcker in recent months, though the rest of the municipal market generally received an exemption. TOB programs have traditionally provided a supply of short-term tax-exempt bonds to money market funds, and have generally accounted for approximately 25%-30% of the assets of muni money market funds.
Vikram Rai, Citigroup vice president of fixed income research, authored a report earlier this year that suggested the joint venture trust as one of two options for keeping TOBs viable under the Volcker regime. Rai warned, however, that "regulators might view this as a re-definition of an existing structure to skirt the rules." The other option he suggested would be to swap the bank sponsor out for a non-banking entity such as a mutual fund or a dealer. This option would not carry the same regulatory risk as the first alternative but would not work for banks.
"Conforming TOB structures to be compliant with the Volcker Rule will help keep the $75 billion TOB market alive, which is credit positive for the muni market because it means compliant TOB trusts will continue to buy long term municipal bonds," Moody's analyst Joann Hempel wrote. "Sustaining the TOB market is also credit positive because TOB trusts that adapt their structures to the new rules will not be forced to dissolve and sell their long-term bond holdings, avoiding adding upward pressure on bond yields and issuers' borrowing cost."
While it is still unclear how big the market for Volcker-compliant TOBs will be, Moody's said, this first deal is a milestone on the road to a structure that will keep TOBs viable after the Volcker Rule becomes effective in July 2015.
