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Crossover Refunding Utilizing Investment Agreement Escrows
Due to the current relatively low U.S. Treasury rates versus municipal
bond rates, and relatively high investment agreement rates versus
Treasury rates, it is now possible to utilize a crossover refunding
to complete advance refundings that are not economically feasible
with traditional open market escrows. In many cases, using a crossover
refunding will produce a yield benefit of 70 basis points or more,
as compared to an open market escrow portfolio.
In a traditional advance refunding, refunding bonds are sold
and the proceeds are used to purchase an open market escrow, or
defeasance escrow, consisting of direct U.S. Government obligations.
The principal and interest from the escrow is used to make the
debt service payments on the refunded bonds until the call date
and to call the bonds on the call date. In a crossover refunding,
the proceeds from the new bond issue are used to purchase an investment
agreement. This investment agreement, which has a higher yield
than an open market escrow, will make the debt service payments
on the new bonds until the call date. On the call date, the investment
agreement matures and the proceeds from the investment agreement
are used to retire the old, or refunded bonds. At that point, the
revenues that previously supported the debt service payments on
the old bonds "crossover" to support the new bonds.
The investment agreements used in crossover refundings are generally
provided by entities rated AAA, Aaa or are collateralized. These
investment agreements currently result in a yield approximately
70 basis points higher than an open market escrow. In order to
comply with U.S. Treasury arbitrage regulations requiring that
investments be purchased at fair market value in an arms length
transaction, the crossover refunding investment agreement is generally
purchased through a competitive bid process.
Obtaining the rate for a crossover refunding investment agreement
can be done very quickly. In order to provide indicative rates
we need only a schedule showing the escrow requirements and the
permitted investment definition. A bid to obtain the investment
agreement can be completed in as little as two days and closing
generally takes place within two weeks.
Other alternatives to a traditional advance refunding are forward
starting swaps and forward bond purchase agreements.
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