Crossover Refunding

What Is Crossover Refunding?

Crossover refunding alludes to the giving of a new bond where the proceeds are put in escrow to reclaim a previously issued higher-interest bond.

How Crossover Refunding Works

Commonly, crossover refunding is used by neighborhood legislatures when they issue new municipal bonds (called pre-refunding bonds) whose proceeds are set in escrow and used to make debt service payments on the refunding bonds until the call date of the original, higher interest rate, municipal bonds. By then, the refunding bond proceeds crossover and are utilized to pay the principal and the call premium and douse the original bond, which is commonly called the refunded bond.

While prevailing interest rates in the economy decline, there is an opportunity for municipal bond issuers to refinance or refund their outstanding bonds at the lower rate. A municipality could likewise choose to refund its bonds to get better debt covenants or to get a better debt service schedule. To accomplish this, the issuer will reclaim the bonds prior to their maturity by paying the principal investment and any accrued interest to bondholders. Be that as it may, the call protection provision for callable bonds prevents borrowers from resigning high coupon paying bonds until the call date indicated on the bond indenture. During this lockout period, the borrowing municipality can issue new bonds (alluded to as refunding bonds) at lower interest rates.

Proceeds from the bond are kept in a escrow account. The investment interest earned in the escrow account is utilized to service the refunding bond until the call date of the outstanding bond. On the call date, the funds in the escrow account crossover to refund or retire the outstanding bonds by paying the interest and principal sums on the debt. During the lockout period, the existing bonds (or refunded bonds) keep on being serviced with the revenue transfer originally pledged to secure them. After the refunded bonds have been paid off with the funds held in escrow, the refunding bonds become payable from the original pledged revenue stream. Consequently, the term "crossover refunding".

In effect, crossover refunding alludes to a method of refunding in which the lien getting the outstanding bond moves over to secure debt payments on the refunding bond, and the escrowed funds which were initially used to cover payments on the refunding bond crossover to pay off bondholders of the outstanding bond. Crossover refunding contrasts from a traditional refunding process in that the proceeds of the refunding bond issue are saved in the escrow account and held there until the call date of the existing issue, at which point any securities in the escrow account are sold to recover the outstanding bond.

At the point when 90 days or less are left in the original bonds' terms, the refunding is called "current". At the point when over 90 days stay, the refunding is called "advance". Alternatives to a crossover refunding incorporate net cash refunding, which is more normal, and full cash or gross refunding, which is more uncommon.