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Advance Refundings of Municipal Bonds

ANDREW ANG, RICHARD C. GREEN, FRANCIS A. LONGSTAFF, YUHANG XING

The Journal of Finance · 2017 · Volume 72 · Issue 4

DOI: 10.1111/jofi.12506

Abstract

The advance refunding of debt is a widespread practice in municipal finance. In an advance refunding, municipalities retire callable bonds early and refund them with bonds with lower coupon rates. We find that 85% of all advance refundings occur at a net present value loss, and that the aggregate losses over the past 20 years exceed $15 billion. We explore why municipalities advance refund their debt at loss. Financially constrained municipalities may face pressure to advance refund since it allows them to reduce short-term cash outflows. We find strong evidence that financial constraints are a major driver of advance refunding activity.

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