Our objective with this post is to provide chief financial officers and other higher education leaders a useful reference as they consider refunding, restructuring and related strategies. Having executed on each of the refunding structures described herein, UMB is well-equipped to assist higher education institutions in the careful application and evaluation of the refunding options in the context of existing bond structure, i.e., optional redemption feature, coupon structure, etc., as well as current market conditions and investor preferences.
Following is a set of three tables highlighting characteristics of strategic options:
- Table 1: Tax-exempt advance refunding. While not currently available under current tax law, it’s useful to lay out the strategy’s basic characteristics for purposes of comparison. The public finance industry continues to lobby at the federal level to bring back the one-time tax-exempt advance refunding option (consistent with pre-tax reform tax law), but such legislation has yet to be passed into law at this time. Should the Internal Revenue Code be revised again to bring back tax-exempt advance refundings, this would certainly be of significant benefit to many municipal issuers/ borrowers. Note the “Better” rating in the “Savings Efficiency” category.
- Table 2: Higher-savings strategies. The second table highlights a set of three strategies that are likely to offer a high degree of savings efficiency (as available within the offering method):
- Tax-Exempt Current Refunding,
- Tax-Exempt Forward Delivery, and
- Tax-Exempt Delayed Draw.
On the potential savings efficiency (outcome) scale, we’ve labeled these options as “Highest,” “High,” and “High,” respectively.
- Table 3: Lower-savings strategies. As with the Seattle University example, a refunding strategy may be applied to meet a higher-education institution’s objectives in the context of tax law limitations, perception of interest rate risk and/or the desire to execute on a common plan of finance (new money combined opportunistically with refunding(s)). The strategies covered in the third table are:
- Tax-Exempt New Money/ Cash Defeasance,
- Taxable to Tax-exempt (Cinderella) Advance Refunding, and
- Taxable Advance Refunding.
The savings efficiency for each strategy is labeled “Better,” “Good” and “Decent,” respectively.
Table 1: Tax-Exempt Advance Refunding (not currently available)
| Refunding structure | Tax-Exempt advance refunding |
|---|---|
| Description | Bond closing occurs outside of 90 days from the call date on the refunded bonds, i.e., longer than 90-day escrow period. |
| Offering: Public market | Yes |
| Offering: Private placement | Yes |
| Offering: Direct purchase | Yes |
| Forward rate consideration | No |
| Interest rate conversion | No, tax-exempt only |
| Delivery of proceeds | All proceeds are funded at closing. |
| Escrow period | Longer than 90 days |
| Escrow investment | SLGS* or OMS** |
| Negative arbitrage | Yes, dependent upon length of and yield in the escrow fund. |
| Savings efficiency | Better |
| Savings dependency | Escrow efficiency |
*SLGS = State and Local Government Series Securities.
**OMS = Open Market Securities, i.e., U.S. Treasuries.
Table 2: Refunding Strategies with Relatively Higher Savings Potential
| Refunding structure | Tax-exempt current refunding | Tax-exempt forward delivery | Tax-exempt delayed draw |
|---|---|---|---|
| Description | Bond closing occurs within 90 days of the call date on the refunded bonds, i.e., less than 90-day escrow period. | Bond closing occurs within 90 days of the call date on the refunded bonds, i.e., less than 90-day escrow period. Bond purchase agreement is executed months in advance of closing/ settlement. | Bond closing occurs only to fund costs of issuance or other tax-exempt eligible purposes. Future draw (funding) occurs on the call date of the refunded bonds or within 90 days. Rate is typically locked at closing. Minimum $50,000 must be funded at closing. |
| Offering: Public market | Yes | Yes | No |
| Offering: Private placement | Yes | Yes | Yes |
| Offering: Direct purchase | Yes | No | Yes |
| Forward rate consideration | No | Yes, forward premium or cash settlement at closing. | Yes, forward premium |
| Interest rate consideration | No, tax-exempt only | No, tax-exempt only | No, tax-exempt only |
| Delivery of proceeds | All proceeds are funded at closing. | All proceeds are funded at closing. | Minimum $50,000 must be funded at closing. |
| Escrow period | Less than 90 days | If funded, less than 90 days | If funded, less than 90 days |
| Escrow investments | SLGS or OMS | SLGS or OMS (If Escrow is funded) |
SLGS or OMS (If Escrow is funded) |
| Negative arbitrage | Minimal to Zero | Minimal to Zero | Minimal to Zero |
| Savings efficiency | Highest | High | High |
| Savings dependency | N/A | Forward Rate Premium | Forward Rate Premium |
Table 3: Strategies with Relatively Lower Savings Potential
| Refunding structure |
Tax-exempt new money / cash defeasance |
Taxable to tax-exempt (Cinderella) advance refunding |
Taxable advance refunding |
|---|---|---|---|
| Description | Bond closing occurs outside of 90 days from the call date on the refunded bonds, i.e., longer than 90 days escrow period. Bonds are issued for new money purposes only, while the issuer uses its cash dedicated to the project to instead cashdefease the refunded bonds. | Bond closing occurs longer than 90 days from the call date of the refunded bonds and the refunding bonds start out as taxable. On the call date or within 90 days, the refunding bonds convert to tax-exempt. Taxable and tax-exempt rates are typically locked at closing. | Bond closing occurs longer than 90 days from the call date of the refunded bonds and the refunding bonds are issued as fully committed taxable. There is no future change in interest rate and the taxable bonds must be refunded by tax-exempt bonds to change status. |
| Offering: Public market | Yes | No | Yes |
| Offering: Private placement | Yes | Yes | Yes |
| Offering: Direct purchase | Yes | Yes | Yes |
| Forward rate consideration | No | Yes, tax-exempt conversion | No |
| Interest rate conversion | No, tax-exempt only | Yes, taxable to tax-exempt | No, taxable only |
| Delivery of proceeds | All proceeds are funded at closing to replenish issuer. | All proceeds are funded at closing. | All proceeds are funded at closing. |
| Escrow period | Longer than 90 days | Longer than 90 days | Longer than 90 days |
| Escrow investments | SLGS or OMS | SLGS or OMS | SLGS or OMS |
| Negative arbitrage | Yes, dependent upon length of and yield in the escrow fund. | Yes, dependent upon length of and yield in the escrow fund. | Yes, dependent upon length of and yield in the escrow fund. |
| Savings efficiency | Better | Good | Decent |
| Savings dependency | Escrow efficiency | Length of taxable rate period; Escrow efficiency | Relative value of taxable rates; Escrow efficiency |
Throughout these tables, note that the high-level, summary information reflects UMB’s evaluation and view on the strategy in general and may not reflect actual results in practice. Not all refunding options described herein may be available to a higher education institution depending upon a confluence of factors including, but not limited to, current tax law, credit quality, bond structure, investor preferences, risk tolerance, etc. As always, we recommend that institutions work closely with your municipal advisor to determine the most favorable approach for your specific situation.
We are committed to serving higher education institutions nationally to maintain their continued financial strength and assist institutions to achieve their growth aspirations. UMB Financial Services, Inc. municipal advisors are well-equipped to assist to help find a quality path forward during these complex conditions. Contact us to connect with a municipal advisor team member.
Disclosures
This communication is provided for informational purposes only and is (1) not an offer or solicitation for the purchase or sale of any financial instrument; (2) not a solicitation to participate in any trading strategy; (3) not an official confirmation of any transaction; and (4) not a recommendation of action to a municipal entity or obligated person and does not otherwise providing municipal advisor advice. The opinions expressed in the communications are those of the author and do not necessarily represent the opinions of UMB Bank, n.a., UMB Financial Services, Inc., or UMB Financial Corporation (Combined hereafter as “UMB”). The communication is based upon information available at the time of publication and is believed to be reliable, but UMB does not warrant its completeness or accuracy, and it is subject to change at any time without notice. UMB is not liable for any errors, omissions, or misstatements. You should discuss any information and material contained in this communication with any and all internal or external advisors or other professionals that are deemed appropriate before acting on this information.
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