C.L. Coonrod & Company Article

Bond Refinancing – Is It a Good Thing?

As a local government executive you will be advised to “refund” a bond issue. It is similar to refinancing a house. You may be given a choice to reduce your payment or to take out more cash for projects. How can that possibly be a bad thing?

To see how, you need to go back to the day the bonds were first issued. Generally, in order to be able to refund the bonds today, a provision had to be included when the bonds were originally issued. The provision is a “call provision”, and it allows you to buy back the bonds before their term.

The problem is that you may have paid dearly for that right.

Bond buyers are smart people, or, at least their advisers are. When your local government issues bonds with call provisions, the bond buyers know what you are up to. They know you will buy back those bonds only if it is in your favor.

From their point of view, that is unfair. If they buy your bonds at a certain interest rate, they would prefer to keep those bonds for the full term.

If you include call provisions when you issue the bonds, your bonds will be less attractive to bond buyers. They will penalize you by bidding higher rates for your bonds. By contrast, if you forego the call dates, then your bonds will be more attractive, and bond buyers will bid lower rates.

Most bonds do have call dates, so the law of supply and demand dictates that a bond without a call date will tend to be treated especially favorably by the bond market.

So here is the bottom line. If your bonds are already issued with call dates, and your financial advisor says you should refund them, it may very well be a good deal.

However, when you issue new bonds, it may be best not to include any call dates. You will probably get a better rate now, which may tend to make up for the fact that you can’t call the bonds in the future.

Is there ever a time you should include call dates? Yes. Let’s say you are issuing bonds at a time when your local government credit is in question. Maybe you have a local employer that is considering closing down a plant and laying off your taxpayers. At that point, the bond market may not offer you a very good rate. It might make sense to take the best deal you can get but include call dates. That way, if your local economy improves, you can call in the old bonds and issue new ones in more favorable circumstances.

However, if your local economy is in normal circumstances and your credit is good when you issue the bonds, it may cost more in the long run to issue them with call dates.

03/14/06

If you have questions or would like further information, please contact us at: Coonrod@CoonrodCPA.com

This article is intended to provide information of general interest to local government officials in Indiana. The information is not guaranteed to be applicable or appropriate in particular circumstances. Local officials should consult competent professionals before acting on any information contained in this article. We are not attorneys. Advice of a legal nature should be sought only from qualified attorneys.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.