What is 'Advance Refunding'

Advance refunding refers to when one bond issuance is used to pay off another outstanding bond. The issue of the new bond is at a lower interest rate than the older, unpaid obligation. Municipalities typically use advance refunding to lower borrowing costs and to take advantage of lower interest rates. Advance refunding can also refer to a bond issuance in which new bonds sell at a lower rate than the outstanding ones. The bond's originator invests the proceeds from the sell, then when calling the older bond investors are paid using the invested proceeds.

BREAKING DOWN 'Advance Refunding'

Advance refunding is most often used by governments seeking to postpone their debt payments rather than having to pay off a large amount of debt in the present. In some ways, this is comparable to a homeowner’s mortgage refinance. In 2017, advance refunding bonds totaled $91 billion and comprised 22.2 percent of the $3.8 trillion total municipal bond market.

Regulators have shown some concern over potential abuses of advance refunding. Since municipal bonds tend to have lower rates, municipalities could potentially use advance refunding to issue unlimited amounts of debt at low rates. The city would then invest in higher rate investments. For this reason, regulators have imposed rules that limit the tax-exempt status of the interest on refunding bonds. Furthermore, because of a provision in the Tax Cuts and Jobs Act of 2017, interest income is not tax-exempt for advance refunding bonds issued after December 31, 2017.

Individual states have laws that impose limits on advance refunding, such as statutory maturities and interest rate limits. The IRS restricts the yield earnings on investments from an advance refunding bond issue. Additionally, arbitrage regulations typically permit municipalities to advance refund bonds one time over the bond’s lifetime. Before initiating advance refunding, cities must first ensure that the amount of money to be saved through the transaction is worth any costs of issuance.

Example of Advance Refunding

Advance refunding is popular in low-interest rate environments, when bond issuers may seek to take advantage of lower rates by refinancing outstanding bonds that have not yet matured. For example, suppose a municipality wants to refinance its current unpaid bonds at a new, lesser rate. The city would take the proceeds from the sale of the refunding bonds and invest them in U.S. Treasuries (t-Bonds) or other taxable government securities. The Treasuries are then deposited into an escrow portfolio. The principal and interest on the Treasuries in the escrow portfolio are used to pay off the old bonds.

  1. Refunded Bond

    Refunded bonds are bonds that have their principal cash amount ...
  2. Refunding

    Refunding is the process of retiring or redeeming an outstanding ...
  3. Refund

    A refund is a payment from the state or federal government for ...
  4. Tax Refund Anticipation Loan, RAL

    A loan provided by a third party against a taxpayer's expected ...
  5. Refunding Escrow Deposits - REDs

    Refunding escrow deposits are type of forward financial contract ...
  6. Arbitrage Bond

    Arbitrage bond is a debt security with a lower interest rate ...
Related Articles
  1. Taxes

    7 Reasons Why You Haven’t Received Your Tax Refund

    The reasons for a delay in getting your tax refund range from incorrect information on your forms to a debt offset. Here are five more, plus remedies.
  2. Taxes

    Taking the Fun out of Tax Refunds

    Getting a tax refund isn't really the big windfall it seems to be. Here's why.
  3. Investing

    The Basics Of Municipal Bonds

    Investing in municipal bonds may offer a tax-free income stream, but such bonds are not without risks. Check out types of bonds and the risk factors of muni-bond.
  4. Investing

    How To Choose The Right Bond For You

    Bond investing is a stable and low-risk way to diversify a portfolio. However, knowing which types of bonds are right for you is not always easy.
  5. Taxes

    12 Reasons Your IRS Refund Was Late

    A tax refund can be a nice post-tax reward, but if it's taking too long to arrive, here are the most likely reasons for the hold-up and how to check on it.
  6. Investing

    Investing in Bonds: 5 Mistakes to Avoid in Today's Market

    Investors need to understand the five mistakes involving interest rate risk, credit risk, complex bonds, markups and inflation to avoid in the bond market.
  7. Investing

    The Best Bet for Retirement Income: Bonds or Bond Funds?

    Retirees seeking income from their investments typically look into bonds. Here's a look at the types of bonds, bond funds and their pros and cons.
  8. Investing

    Why Bond Prices Fall When Interest Rates Rise

    Never invest in something you don’t understand. Bonds are no exception.
  9. Investing

    Corporate Bonds for Retirement Accounts

    Corporate bonds are usually the preferred choice in retirement accounts. Here are some of the benefits of corporate bonds, and strategies for a portfolio.
  10. Investing

    Muni Bonds, Taxable Bonds or CDs: Which is Best?

    Here's how to tell if municipal bonds are a better investment than taxable bonds or CDs.
  1. Which factors most influence fixed income securities?

    Learn about the main factors that impact the price of fixed income securities, and understand the various types of risk associated ... Read Answer >>
Hot Definitions
  1. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  2. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  3. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  4. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
  5. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  6. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
Trading Center