What was tax-exempt advance refunding and why was it eliminated?

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AcadiFi · Accepted Answer

Advance refunding was a technique where an issuer issued new bonds (refunding bonds) and placed the proceeds in an escrow of US Treasury securities to pay off callable outstanding bonds at their future call date — usually to lock in lower rates years before the call. The outstanding bonds were 'defeased in substance' but remained outstanding until called. The 2017 Tax Cuts and Jobs Act (TCJA) ELIMINATED tax-exempt advance refundings starting January 1, 2018. Issuers can still do CURRENT refundings (within 90 days of call date) on a tax-exempt basis, and TAXABLE advance refundings are still legal — just not tax-exempt. Example (pre-2018): the City of Willowcrest had $120M in 5.25% bonds callable in 2022. In 2015, rates fell to 3.4%. The city issued $130M refunding bonds at 3.4%, escrowed proceeds in Treasuries yielding ~2.9%, and saved ~$15M NPV in debt service over the remaining life. Post-TCJA, this isn't possible tax-exempt; the city must wait until 2022 (90 days before call) to refund tax-exempt, OR issue a taxable advance refunding at higher rates and smaller savings. Many 2020-2021 issuers did taxable advance refundings when rates hit historic lows — accepting the higher taxable coupon to lock in savings.

What was tax-exempt advance refunding and why was it eliminated?

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