Forward bond purchase rights for advance refundings.

• Author: Tigue, Patricia
• Position: Innovation in Debt Finance

Governmental issuers are continually looking for ways to hold down the costs associated with their bond programs. The Triborough Bridge and Tunnel Authority (TBTA) in New York City is no exception. With interest rates at comparatively low levels, the TBTA has sought opportunities to realize savings by advance refunding outstanding debt issued in high interest rate environments. When restrictions stemming from federal tax regulations limited its ability to advance refund certain bonds, the TBTA looked for alternative ways to achieve the advantages of an advance refunding. The sale of forward bond purchase rights permitted the authority to achieve savings with an acceptable level of risk.

The Triborough Bridge and Tunnel Authority, an operating division of the New York Metropolitan Transportation Authority (MTA), is responsible for operating seven bridges and two tunnels in New York City. Currently, the TBTA has nearly $5 billion of outstanding debt, including general purpose revenue bonds, special obligation bonds, and beneficial interest certificates.

Early in 1995, TBTA was presented with a proposal to enter into a contract to sell forward bond purchase rights in connection with certain maturities of its general purpose revenue bonds, Series L. These bonds had been issued to advance refund the authority's Series D bonds and thus were not eligible to be advance refunded. Under current federal tax regulations, bonds issued prior to 1986 for governmental purposes or 501(c)3 projects generally may be advance refunded twice, while bonds issued after 1985 are able to be advance refunded one time. Private activity bonds (other than 501(c)3 bonds) may not be advance refunded at any time. These limitations have made it more difficult for governmental issuers to take advantage of falling interest rates.

The sale of forward bond purchase rights is an instrument developed by investment bankers to get around this problem. Forward purchase rights give the holder the right but not the obligation to require an issuer to sell bonds on some future date. In exchange for this right, the investor makes an up-front payment to the issuer. These agreements are structured based on today's yield curve; thus, the issuer is able to take advantage of the current interest rate environment for bonds that will be issued in the future. The use of these instruments permits issuers who are unable to advance refund certain bonds to obtain some of the same benefits without...