Taxable advance refundings a critical examination Andrew Kalotay
By: Kalotay, Andrew
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Material type: 
ArticlePublisher: 2021Subject(s): BONOS | IMPUESTOS | AHORRO | ESTADOS UNIDOS
In:
Journal of Taxation of Investments v. 39, n. 1, Fall 2021, p. 49-60Summary: The Tax Cuts and Jobs Act of 2017 (TCJA) eliminated advance refundings with tax-exempt bonds but it is silent on advance refundings with taxable bonds. In today’s low interest rate environment, such taxable refundings have become a trend. Although these transactions generate large savings, the odds favor waiting until the call date and then refunding with tax-exempt bonds. Unless interest rates rise significantly, waiting would result in much greater savings. The interest rate risk can be mitigated by issuing callable taxable bonds, which afford eventual refunding with tax-exempt bonds. However, this strategy does not improve the economics significantly—the higher coupon of the callable bonds reduces the savings until they are called. The typical savings from taxable refundings extract only about 70% of the forfeited option value of the refunded bonds.
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Resumen.
The Tax Cuts and Jobs Act of 2017 (TCJA) eliminated advance refundings with tax-exempt bonds but it is silent on advance refundings with taxable bonds. In today’s low interest rate environment, such taxable refundings have become a trend. Although these transactions generate large savings, the odds favor waiting until the call date and then refunding with tax-exempt bonds. Unless interest rates rise significantly, waiting would result in much greater savings. The interest rate risk can be mitigated by issuing callable taxable bonds, which afford eventual refunding with tax-exempt bonds. However, this strategy does not improve the economics significantly—the higher coupon of the callable bonds reduces the savings until they are called. The typical savings from taxable refundings extract only about 70% of the forfeited option value of the refunded bonds.
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