Short-term notes

General obligation (G.O.) and revenue bonds are generally long-term debt securities. Municipalities requiring short-term funding typically issue notes. These securities range in maturity between three months and three years. We’ll discuss the following in this section:

• Anticipation notes, including:
  • Tax anticipation notes (TANs)
  • Revenue anticipation notes (RANs)
  • Tax and revenue anticipation notes (TRANs)
  • Bond anticipation notes (BANs)
  • Grant anticipation notes (GANs)
• Variable rate demand notes (VRDNs)

Anticipation notes

A municipality can issue anticipation notes if they want to utilize funds before they’ve been collected. There are a few different versions, but they all have the same theme. Municipalities borrow money for a short period, spend that money, and use taxes, revenues, or capital (money) received in the future to pay back borrowed funds. Now, let’s discuss the specific types of anticipation notes.

Tax anticipation notes (TANs)

Tax anticipation notes (TANs) allow a municipality to spend money on a public project and repay borrowed funds with future tax collections. For example, assume a city wants to renovate a local public park but doesn’t have the necessary funds. If tax collections come in a few months, they can issue a TAN. By doing so, the city borrows money for a short time and performs the renovations. A few months later, they’ll use tax collections to pay back the borrowed funds. This is sometimes called “smoothing out” cash flow, as it allows municipalities to utilize taxes throughout the year.

Revenue anticipation notes (RANs)

The same idea applies to revenue anticipation notes (RANs), but funds are used for revenue-related projects. Assume a city owns a zoo and wants to expand it. A RAN can be issued to fund the expansion. After completion, the municipality uses future revenue collections from the zoo to “smoothing out” its cash flow.

Tax and revenue anticipation notes (TRANs)

Tax and revenue anticipation notes (TRANs) combine TANs and RANs. If a municipality wants to spend money on multiple projects but only wants to issue one form of debt, TRANs can do it. Once the money is spent, the municipality uses future tax and revenue collections to repay the borrowed funds.

Bond anticipation notes (BANs)

Bond anticipation notes (BANs) are issued before a long-term bond issuance. Assume a city plans to fund the building of a new high school by issuing a G.O. bond. A BAN could be issued before the bond offering to pay for architect blueprints and land surveys. When the bond is sold in the future, the municipality will use a portion of the bond proceeds to pay off the smaller BAN.

Grant anticipation notes (GANs)

Grant anticipation notes (GANs) are issued when a federal grant is expected or awarded. The federal government commonly awards grants to municipalities, which is essentially free money. Assume a state is awarded a grant to grow and improve its public transportation system. Before receiving the money, the city can issue a GAN to pay for up-front research costs on utilizing the grant money most efficiently. Grants are often provided for projects the federal government views as beneficial (e.g., environmentally friendly projects).

Variable rate demand notes (VRDNs)

Variable rate demand notes (VRDNs), also known as variable rate demand obligations (VRDOs), are considered a form of short-term municipal debt. When an investor purchases this security, they obtain a variable rate bond with a put option. On a set schedule (usually every few weeks or months), the note resets its interest rate to the current market interest rate. Unlike normal bonds with fixed coupons, VRDNs offer investors varying interest payments.

While VRDNs allow investors to hold them for short periods due to their put options, they are typically issued with long-term maturities. This structure provides the investor with added flexibility. If the investor wants to continue collecting interest payments for long periods, they can. If the investor wants to exercise the put option to redeem their security at par, they can. Therefore, VRDNs can be viewed as both long and short-term securities, although they technically are long-term debt securities that can be redeemed in the short term.

VRDN holders commonly utilize the put option if unsatisfied with the new interest rate. As a reminder, bond put options allow the investors to sell the bond back to the issuer at its par value. Essentially, the investor decides when the investment is finished.

VRDNs (and anything with a variable coupon) are not subject to significant market price changes when interest rates fluctuate. If interest rates rise, investors know the coupon is adjusted to a higher rate on the reset day. Additionally, the VRDN can always be “put back” to the issuer at par. Therefore, VRDN market prices typically do not deviate far from the par value.