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.