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Taxable Advance Refundings: A Critical Examination  

Author:  Andrew Kalotay.

Source: Volume 41, Number 04, Winter 2021 , pp.49-59(11)

Municipal Finance Journal

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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.

Keywords: Advance refundings, Tax Cuts and Jobs Act of 2017 (TCJA), tax-exempt bonds, callable taxable bonds, option value, present value savings

Affiliations:  1: Andrew Kalotay Associates, Inc..

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