The Treasury established SLGS in 1972.
In tax-exempt transactions, issuers are usually not permitted to earn above their bonds’ borrowing cost, called the arbitrage yield, when investing the bond proceeds. SLGS are a security offered by the Treasury to issuers in order to meet this reinvestment restriction while still earning some yield on invested proceeds. SLGS are also used by municipalities to ensure that they are paying the fair market price for securities in the open market. The Treasury sets the SLGS rate at a fair market price each morning and that rate is held throughout the day.
There are two types of SLGS:
- Time Deposit Series – these securities have interest rates approximately one basis point below the current borrowing rate for Treasury securities of comparable maturity. Rates are set daily by 10:00 a.m. EST and are available on the Treasury Direct website. Notes and bonds pay interest semiannually, while certificates of indebtedness pay at maturity. The minimum purchase of a time deposit series is $1,000, and investors may purchase them in any whole dollar amount.
- Demand Deposit Series – these securities act more like variable-rate debt. They automatically roll over with interest each day until redemption is requested. Interest is accrued and added to the principal daily, and the interest rate is based on an adjustment of the three-month Treasury bill’s average yield. The minimum purchase of a demand deposit SLGS is $1,000. Unlike the time deposit SLGS, it is not required to be in whole dollar amounts.
Example:
A municipality issues a tax-exempt bond to refund an outstanding bond issue. The outstanding bonds are not callable for two years so the refunding bond proceeds must be invested in an escrow account. The municipality invests the bond’s proceeds until the cash flow is needed to pay off the outstanding bonds, but it cannot invest in instruments that offer above the bond’s borrowing rate – that is, its arbitrage yield – because of the bond’s tax-exempt status. The municipality can buy SLGS from the US Treasury.
What’s important here?
The Treasury established the State and Local Government Series in 1972 because issuers are mostly prohibited from investing tax-exempt bond proceeds in instruments that are higher yielding than the borrowing rate of their bond issue.
SLGS are only sold to state and local tax-exempt debt issuers to help them earn yield while complying with their borrowing rate restrictions.
