Frequently Asked Questions
Find answers below to some of the basic questions about how EMMA works, what are
the key features of municipal securities, how you should read an official statement,
what is an advance refunding, and how to understand the price and other terms of
a bond trade.
About Advance Refunding Documents
- What is an advance refunding?
A refunding is a refinancing of existing "refunded" bonds with new "refunding" bonds.
Most refundings can be compared to the refinancing of a home mortgage, where a homeowner
obtains a new mortgage with a lower rate to pay off an older, more expensive mortgage.
Similarly, the issuer of refunding bonds often seeks to lower its interest payments
by paying off bonds it has previously issued with newly issued refunding bonds that
pay interest at a lower rate than the original refunded bonds. However, in some
cases, an issuer may advance refund existing bonds for reasons other than interest
cost savings, for example, where an issuer seeks to be released from covenants made
when issuing the original bonds.
An important difference between an "advance" refunding and a typical refinancing
of a home mortgage is that, rather than paying off the old debt immediately upon
incurring the new debt, the proceeds of the new refunding bonds are placed in an
escrow account to be applied according to a predetermined schedule to the future
payment of principal and interest on the old refunded bonds. Thus, the refunded
bonds are not paid off immediately, but instead will be paid off either as originally
scheduled at maturity or on an earlier redemption date in the future according to
the bonds' original redemption, or "call," provisions. The terms of the payment
of the refunded bonds are set out in the advance refunding document, often referred
to as an escrow deposit agreement.
- How am I affected if my bond is advance
The advance refunding of a bond typically will result in a change in the security
for repayment of the bond and often will result in the bond being paid prior to
maturity. Thus, an advance refunding of your bond can change the timing of the repayment
of principal, the credit rating on your bond, and the current value of your bond.
A change in value of your bond may be reflected on your account statement or can
affect the price you receive if you choose to sell your bond.
The refunded bond, which may previously have been secured by a specific revenue
source pledged by the issuer to repayment of the bond - such as a tax levied by
the issuer, the revenues generated by a facility financed with bond proceeds, or
a variety of other sources - will now be secured exclusively by the escrow account
established under the advance refunding document. Often, the legal documents that
controlled the security provisions for the bonds will be said to have been "defeased",
meaning that those provisions generally no longer apply to the bonds. Such legal
documents typically establish requirements for the quality of investments that must
be placed in escrow in order to defease the lien placed on the security for the
bonds. It is not unusual for bonds that have been advance refunded to receive a
higher credit rating from one or more credit rating agencies due to the establishment
of an escrow account holding highly rated investments. This, in turn, can often
(but not always) result in a higher market value being placed on the refunded bond
than before the refunding.
- Why should I read an advance refunding
The advance refunding document sets out important terms of how and when a bond that
has been advance refunded ultimately will be paid. The escrow account for the refunded
bonds is typically established under the advance refunding document, with the document
describing how funds in the escrow account will be invested prior to being used
to pay the refunded bonds. Although practices vary, the advance refunding document
usually will identify the specific investments being held in escrow. In addition,
the advance refunding document generally provides information about whether the
advance refunded bond will be paid at maturity or will be called for redemption
prior to maturity, including a schedule of payments to be made out of the escrow
account corresponding to a schedule of redemptions and maturities. Where less than
an entire maturity of a bond is scheduled to be redeemed, the advance refunding
document may lay out the process for selecting which bonds of that maturity will
be redeemed. In the case of many escrowed-to-maturity advance refundings, this document
also may specify whether the issuer has retained the right to later call the bonds
prior to maturity.
- Why can't I find an advance refunding
document for bonds that have been refunded?
An advance refunding document does not exist in every case in which bonds are being
refunded. A bond can be refunded in what is called a "current" refunding, in which
the bonds are paid off either immediately upon issuance of the refunding bonds or
within 90 days of issuance. In such cases, an advance refunding document typically
is not used or, if one exists, is not required to be submitted to the MSRB. In some
cases, the legal documents under which the outstanding bonds were issued may provide
a mechanism for advance refunding bonds that does not require the establishment
of an escrow under a separate document, in which case no advance refunding document
may exist. In other cases, an escrow may be established for outstanding bonds from
moneys available to the issuer other than from the issuance of advance refunding
bonds, such as where an issuer sells a bond-financed facility and then applies the
proceeds of that sale to repay the original bonds. No advance refunding documents
are required to be filed with the MSRB if no advance refunding bonds were issued
to refund the old bonds, or if the underwriter is otherwise exempted from submitting
an official statement to the MSRB under exemptions provided under MSRB and SEC rules.
Finally, underwriters were not required to submit advance refunding documents to
the MSRB prior to 1990.
- What does "escrowed-to-maturity" mean?
In some cases, bonds may be "escrowed-to-maturity," which means that moneys held
in the escrow account will be used to pay the interest on the bonds as they were
originally scheduled to be paid and that the principal amount of the bonds will
be paid at maturity, rather than being redeemed prior to maturity. Thus, the advance
refunding does not affect the final maturity date of refunded bonds that are escrowed-to-maturity.
Investors should be aware, however, that in some cases, an issuer may reserve the
right to call an escrowed-to-maturity bond prior to maturity.
- What does it mean if an issuer has
reserved a right to call bonds that have been advance refunded?
In some cases, an issuer may reserve the right to call an escrowed-to-maturity bond
prior to maturity. For example, an issuer may advance refund a bond that is scheduled
to mature on January 1, 2030. Even though the legal documents would allow the issuer
to call these bonds for redemption in 2015, the issuer may instead establish an
escrow that will continue to pay interest through January 1, 2030 and then will
be applied to pay the principal amount due on January 1, 2030. This bond has been
escrowed-to-maturity. However, the issuer may have included in the advance refunding
document a specific reservation of its right to later exercise the 2015 call provision.
In that case, the issuer may choose to redeem the bonds in 2015, even though the
escrow is fully funded to pay the bonds through maturity.
- How are "refunding" bonds different
from "refunded" bonds?
Refunding bonds are the new bonds issued in a refunding. Refunded bonds are the
old or "outstanding" bonds being refinanced in a refunding.
- What types of advance refundings exist?
While the basics of advance refunding remain the same, there are different types
of advance refundings. For example, in a "crossover refunding," the revenue stream
originally pledged to secure the refunded bonds (such as tolls or taxes) continues
to be used to pay the interest and principal on the refunded bonds until they mature
or are called. At that time, the pledged revenues "cross over" to pay the interest
and principal on the refunding bonds while escrowed securities are used to pay the
refunded bonds. In a "full cash" or "gross refunding," the proceeds of the refunding
bonds are not reinvested, but rather provide sufficient funds in and of themselves
to pay interest and principal on the refunded bonds. In a "net cash refunding,"
the proceeds of refunding bonds are combined with other available funds to pay the
interest and principal on the refunded bonds.
Additionally, there are situations that achieve the same practical effect as an
advance refunding, although they are not technically such. In a "forward refunding,"
an issuer agrees to issue bonds on a specified future date and an underwriter agrees
to purchase such bonds on that date. The proceeds of such bonds are used to currently
refund the issuer's outstanding bonds. In a "synthetic refunding," the issuer and
a counter-party enter into an agreement designed to generate savings for the issuer
such as payments from the counter-party to the issuer in return for specific action
of the issuer.
The descriptions included in the FAQs above are generalizations and do not necessarily
accurately represent the terms of any specific security. You must read the disclosure
materials and other relevant documents to fully understand your security.