Extraordinary Redemption
What is Extraordinary Redemption?
An extraordinary redemption is a provision that gives a bond issuer the right to call their bonds due to an unusual event, like a catastrophe that influences the source of the bond's revenue. An extraordinary redemption feature must be determined in the bond's offering statement.
Figuring out Extraordinary Redemption
An extraordinary redemption means the issuer recovers the bond at par before the bond develops due to unusual conditions that influences the source of revenue. Extraordinary event clauses can be either mandatory or optional, meaning the trigger event can either require the company to recover the bonds or give the company the option to do as such. Terms of an extraordinary redemption must be framed in the bond's offering statement.
A common situation under which a bond could be called is a drop in interest rates, which would permit the issuer to refinance by giving new bonds at a lower rate. This provision may likewise be utilized to retire single-family mortgage revenue bonds or mortgage-backed securities when a large number of homeowners refinance their mortgages. Instances of bonds with extraordinary redemption features are water and sewer bonds, housing bonds, and Build America Bonds (BABs).
Extraordinary redemption provisions are found in some municipal bonds. One type of a municipal bond is the revenue bond, which is reimbursed from the revenue generated from the project it funds. For instance, a revenue bond might be issued to fund an airport, with revenue generated from gate fees, charges, and taxes used to service the debt. In any case, assuming an adverse event influences the airport's ability to generate revenue, the issuer could choose for trigger the extraordinary redemption clause.
Extraordinary redemption, additionally called extraordinary call, is generally commonly practiced if:
- bond proceeds are not spent as framed
- bond proceeds are utilized such that influences the tax status of the interest acquired
- a catastrophe influences the project being financed
Build America Bonds (BABs)
BABs were issued in 2010 as an approach to assisting municipalities with keeping up with solvency during the economic recession. The government offered issuers and bondholders a 35% subsidy of the interest payments by means of tax credits, lessening the issuer's borrowing costs and the bondholder's tax liability. In the event that the federal government were to fail to pay the guaranteed 35% of the issuer's interest payments or reduce the subsidy, the extraordinary redemption provision could be enacted and the bonds could be recovered out of the blue.
As a matter of fact, when the government reduced the subsidy from 35% to 28%, a few issuers quickly acted and called in high coupon bonds and supplanted them with new bonds issued at the lower rate.
Extraordinary Redemption versus Customary Calls
A standard or fixed call is scheduled and can be practiced by the issuer on the off chance that interest rates drop to a level that makes bond refinancing monetarily beneficial to the issuer. The trust indenture records the call date or dates on which the issuer can recover the bonds. Bonds can't be reclaimed before these dates.
An extraordinary redemption, then again, is a call option which gives the issuer the right, yet not the obligation, to call the bonds when trigger events happen. The bond retirement is unscheduled and must be called because of a genuine catastrophic event, normally prior to the completion of the project.
Highlights
- An extraordinary redemption means the issuer can reclaim the bond at par before the bond develops.
- An extraordinary redemption is a provision that gives a bond issuer the right to call back bonds due to an unusual event, like a catastrophe that influences the source of the bond's revenue.
- Extraordinary redemption, likewise called extraordinary call, is most commonly practiced when bond proceeds are not spent by schedule or a catastrophe influences the financed project.
