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Timing Tax Exempt Bond Refundings

By: Jeffrey B. Sahrbeck
(HFMA September 2015)

Selecting the optimal time to refund tax-exempt bonds can significantly enhance a healthcare organization’s economics, but is dependent on both market factors and timing.

Unlike in the taxable world, where bonds are generally non-callable to maturity or include a make-whole call where there is no economic benefit to refunding, most tax-exempt fixed-rate bonds can be redeemed after 10 years at par. This difference gives hospitals significant flexibility to replace bonds with lower-cost debt at any time between the redemption date and final maturity if rates decline. For example, many bonds issued in the aftermath of the credit crisis bear significantly higher yields than current market levels, creating the potential for significant savings.  

As the call dates (generally 2018-21) for these bonds approach, many hospitals have the additional option of refunding their bonds in advance by issuing new bonds to fund an escrow that pays off the old bonds on the redemption date. However, there is often a significant difference between the cost to fund the escrow and the cost to redeem the bonds in the future, because yields on investments eligible to fund the escrow are significantly lower than the cost of the existing debt. Thus, to take advantage of today’s lower rates, hospitals are required to “pay” the additional cost of this “negative arbitrage.”

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