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The Ins and Outs of Investment Agreements
What is an investment agreement?
An investment agreement is a contract between a bond issuer and the
provider of the investment agreement (typically a subsidiary of a
bank or other financial institution). The provider agrees to invest
the issuer’s funds, such as a debt service reserve and construction
funds, at a guaranteed interest rate. In addition to the interest
rate, the agreement specifies the length of time the funds are to
be invested and the instruments in which the provider is allowed
to invest, which may include Treasury securities, agency obligations
and commercial paper.
Are there different types of investment agreements?
Generally, an investment agreement may be collateralized or uncollateralized.
Under a collateralized investment agreement the provider is required to deliver
eligible securities—the value of which is at least equal to the amount
invested—to a third party, such as the bond trustee. Alternatively, a
provider of an uncollateralized agreement is not required to provide eligible
securities to the trustee. Rather, the provider’s guarantee assures that
the invested proceeds will be available to the issuer for withdrawal
whenever they are needed. Uncollateralized agreements often include requirements
to deliver securities as collateral if or when the provider’s credit rating
deteriorates. The interest rate under an uncollateralized agreement typically
is higher than for a fully collateralized agreement with the same
terms (approximately 20 basis points, depending on the eligible collateral).
Can monies held under an investment agreement be withdrawn at any time?
The withdrawals from investment agreement funds may be either flexible or
fixed. If they are fixed, the investment provider has guaranteed an interest
rate based on the schedule of withdrawals and the expected life of the
investment. For example, an issuer of fixed-rate bonds may wish to prescribe
the withdrawals from a capitalized interest investment agreement, since the
issuer’s interest requirements are predictable. A flexible investment
agreement allows the issuer to make withdrawals of any amount and at any
time. This type of agreement is best suited for construction funds. In some
cases, issuers know the withdrawals required for a construction project at
the time the agreement is executed, and a fixed draw agreement may be
suitable. An agreement with fixed withdrawals typically would provide a
slightly higher interest rate than for a comparable flexible agreement
because the provider can plan investments more efficiently.
How do I select an investment agreement?
Whenever tax-exempt bond proceeds are invested, agreements must be bid
out to eligible providers, as required under Treasury regulations. At
least three bona fide bids must be received to determine that the bids
are fair in the market, among other rules.
What is the benefit of an investment agreement?
Investment agreements can be structured to meet virtually any issuer’s needs
for investment of bond proceeds. The interest earnings may often be higher
than if the issuer pursued its own investment strategy using securities
of a similar credit rating. An investment agreement minimizes market
risk—the risk that the price for securities will decline when sold—associated
with most securities.
How much does an investment agreement cost?
The brokerage fees associated with investment agreements are paid by the
provider, so there is no cash cost to the issuer. However, the provider
recovers the brokerage fees by building the fee into the guaranteed interest
rate.
Can an investment agreement be terminated?
Typically, an investment agreement cannot be terminated early by the
provider. An agreement may be terminated by the issuer, but there may
be costs associated with early cancellation. While investment agreement
terms vary significantly, the issuer may be entitled to a payment depending
on the interest rates prevailing in the market at the time the agreement
is terminated. Generally, if interest rates have decreased since the time
the agreement was executed, the issuer may receive a payment from the provider.
Issuer Spotlight: Anson Education Facilities Corporation
Anson Education Facilities Corporation issued $55.4 million of tax-exempt bonds on
behalf of The University of Texas at Dallas. Proceeds were used to purchase a
series of student housing facilities (the Waterview Park) located on the University’s
campus. The facilities were originally constructed and owned by a third-party
developer, but were acquired by a newly created foundation solely for the benefit
of the University.
A portion of the bond proceeds was used to fund a reserve equal to one year’s debt
service, or $3.5 million. This reserve remains in place until the final maturity of
the bonds in 2034.
The issuer chose to invest the reserve in an uncollateralized investment agreement
with a ‘AAA’ rated provider.
“By using an investment agreement, our foundation was able to avoid the risk of
investing a relatively small amount of money in the market on an ongoing basis
and ensure a competitive return on that investment,” said Senior Vice President
for Business Affairs for The University of Texas at Dallas Robert Lovitt.
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