Escrowed to Maturity

What Is Escrowed to Maturity?

Escrowed to maturity alludes to the placement of funds from another bond issue into a escrow account to pay off a more seasoned bond's periodic coupon payments and, eventually, the principal on its maturity date. The money that fills in the escrow account is ultimately used to pay down the original bond, which assists issuers with borrowing at lower rates.

Figuring out Escrowed to Maturity

Escrowed to maturity portrays the course of a issuer investing and holding the proceeds from new bond sales in an escrow account to cover the existing commitments to the holders of a previously issued bond.

Escrowed to maturity municipal bonds are a form of pre-funded municipal bonds, which are backed by Treasury securities held in an escrow account. In this case, the issuer holds proceeds from another bond issue in an escrow account and puts them in high credit securities to fund the interest and principal payments to the original bondholder.

Pre-funded municipal bonds assist an issuer with getting a better credit rating on its debt. Since state-issued municipal bonds are not backed by the full faith of the U.S. government, the quality of the underlying assets is important to guarantee proceeded with interest payments and to limit the risk of default.

The bonds are pre-funded in light of the fact that the issuer needs to generates no income to pay the coupon to investors. Payments are made through the escrow account that contains the Treasury securities that create interest to pay the coupon. In that capacity, the bond and the Treasury securities will quite often have a similar maturity. Pre-funded bonds assist municipal issuers with lessening their long-term borrowing costs.

Using Escrowed to Maturity

Pre-funded municipal bonds, which incorporate escrowed to maturity bonds, are securities that a bond issuer has called, or bought back, from the bondholder before it has matured. Issuers frequently settle on decisions during periods of declining interest rates. By paying off their high-interest debt, the issuer can sell new bonds at lower rates.

Notwithstanding, most bonds contain provisions that prevent the issuer from settling on that decision before a specific date, typically a few years after they've been issued. So if the issuer has any desire to exploit lower rates before that call date shows up, they could utilize pre-funded bonds.

With escrowed to maturity bonds, the issuer sells new bonds to cover the cost of calling those bonds that they've previously issued. On arriving at the call date of the original bonds, the issuer utilizes proceeds from the new bond sales to pay their owners.

The issuer typically contributes proceeds from the distribution of the new bonds in U.S. Treasuries and holds them in an escrow account. By choosing Treasuries that mature while the issuer needs to call the original bonds, they can repay the principal and full interest owed at maturity of the outstanding bond to the original bondholders.

Benefits of Escrowed to Maturity

Escrowed to maturity bonds are unique in that they have the tax-advantaged treatment of a municipal bond with the relative safety of a government-issued security. This outcomes in a possibly better after-tax yield than an investor would receive on a bond with comparative duration and risk.

For instance, you're picking either a two-year Treasury and a municipal bond with an original maturity of 10 years escrowed to maturity in two years. Almost certainly, called municipal bonds will offer a better yield than the Treasury, and the interest payments will be free of both state and federal taxes.

Highlights

• Investors typically receive a better after-tax yield from escrowed to maturity bonds than they would on a bond with comparable duration and risk.
• Escrowed to maturity bonds likewise accompany the relative safety of a government-issued security as that is the underlying asset.
• Escrowed to maturity alludes to the placement of funds from another bond issue in an escrow account to pay off a more seasoned bond's periodic coupon payments and principal.
• Escrowed to maturity municipal bonds are a form of pre-funded municipal bonds, which are backed by Treasury securities held in an escrow account.
• The holders of escrowed to maturity bonds have the tax-advantaged treatment of a municipal bond with the relative safety of a government-issued security.