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4 Years On, Alternatives to Tax-Exempt Advance Refundings Continue to Proliferate

April 1, 2022

Reprinted with permission from the March 31, 2022 edition of The Legal Intelligencer © 2022 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.

By Timothy J. Horstmann and Frannie Reilly

In December 2017, former President Donald Trump signed into law the Tax Cuts and Jobs Act. Among the many provisions of the act was a provision that eliminated the tax exemption for municipal bonds that advance refunded another series of bonds. Prior to its passage, issuers had the ability to issue such bonds on a tax-exempt basis, and did so for a variety of reasons, including to achieve debt service savings. With the loss of tax-exempt status for advance refunding bonds issued after the passage of the act, issuers and their advisers have searched for alternatives to the traditional tax-exempt advance refunding model.

In this article, we explore some of the alternatives that issuers have applied to achieve the same or similar benefits that would be achieved with a traditional tax-exempt advance refunding. First, we discuss the use of “forward delivery” bonds, where the bonds are sold, but not delivered to investors until a much later date in the future; second, we consider so-called “Cinderella” bonds, which are issued taxable but later convert to tax-exempt; and finally, “tenders and exchanges,” where issuers, often in conjunction with a current issuance, make an offer to investors to acquire their outstanding bonds, either for purchase or exchange.

A Refresher on Advance Refundings

Municipal bonds are not like your typical mortgage or loan, which generally may be prepaid at any time. Rather, municipal bonds are issued subject to a specified initial term of years during which the bonds may not be prepaid. This term is usually at least five years and may be as long as 10 years. The date on and after which the bonds may be prepaid is called the “call date.”

However, issuers may still desire to issue bonds in advance of the call date, for instance, to lock in debt service savings before interest rates rise. In such a case, the issuer would issue the bonds, and use the proceeds to make any regular principal and interest payments on the outstanding debt until the call date is reached. Under Section 149(d) of the Internal Revenue Code and the relevant Treasury regulations, such a transaction is an advance refunding, if the new bonds are issued more than 90 days before the call date on the bonds to be prepaid. Bonds issued within that 90-day period are called current refunding bonds.

Section 149(d) generally had provided that a series of tax-exempt bonds could be advance refunded on a tax-exempt basis only one time. However, pursuant to the act this exemption was eliminated for advance refunding bonds issued after Dec. 31, 2017. As a result, interest paid on any advance refunding bonds issued after this date is subject to federal income tax.

Of course, issuers retain the ability to issue advance refunding bonds on a taxable basis. And many have, and continue to do so, despite the fact that the interest paid by the issuer on such bonds would be higher than that paid on an equivalent tax-exempt series. Faced with long waits until call dates, and with interest rates at historic lows over the last few years, some issuers determined to issue taxable advance refunding bonds to lock in savings immediately.

Under the right circumstances, however, issuers might consider alternative financing structures in an effort to wring more savings from the typical taxable advance refunding model. We discuss three of these alternatives below.

Forward Delivery Bonds

One alternative to advance refundings is for the issuer to issue forward delivery bonds. A forward delivery bond is a bond that is priced on a determined date but is not issued until a date in the future. That future date is the date that is within the 90 days before the redemption, so that the bonds can be issued as current refunding bonds, not advance refunding bonds. Thus, issuers benefit from issuing forward delivery bonds by locking in current market interest rates for a tax-exempt current refunding that will be issued in the future.

These types of bonds are sold to investors based on predetermined interest rates that are set on the date of the sale, not the date of delivery. Thus, the investor is providing a guarantee to the issuer of a certain interest rate at a set time in the future. The length of time associated with a forward delivery contract will vary, from as little as a few months to as long as a few years, depending on the issuer’s need for financing and the credit risk associated with the issuer. In contrast, traditional bonds are delivered usually within 30 days of pricing.

In general, there is usually a yield premium associated with forward delivery bonds due to the illiquidity of the bonds. However, issuers may determine that the premium is still a financially viable option given the (presumably lower) interest rate the issuer will achieve in comparison to an immediate taxable advance refunding or a later current refunding, when rates may be higher.

Because of the (potentially substantial) delay from pricing until delivery, forward delivery bonds come with certain risks not present in traditional bond models. Forward delivery bonds essentially will have two closings to account for those risks: one shortly after the sale date, and the other on the actual date of delivery. The “two closings” model is done to ensure that there has been no change in the law or facts during the interim that would make delivery of the bonds impossible.

Issuers should understand that certain material events may impact the investors’ obligation to purchase the forward delivery bonds under the forward delivery contract. For this reason, issuers should review these closing conditions with counsel. In addition, because the determination of the tax-exempt status of the forward delivery bonds occurs on the date of delivery, bond counsel generally will conduct additional due diligence prior to delivering its opinion, to ensure that there has been no change in the law or facts prior to the delivery date that would affect its ability to deliver the opinion.

‘Cinderella’ Bonds

Another alternative to tax-exempt advance refundings is the so-called “Cinderella” structure: the issuer issues a series of taxable advance refunding bonds, which later converts to a tax-exempt structure when the conditions for tax-exempt status are met (i.e., reaching the 90-day window for a tax-exempt current refunding). The date of conversion can be months or even years in the future.

“Cinderella” refundings generally take the form of a private placement where the issuer sells its bonds directly to a bank, rather than by a public offering to investors through the municipal market. The bank agrees up-front on both a taxable and tax-exempt interest rate to be paid by the issuer. There issuer is able to lock in its savings immediately.

“Cinderella” refundings must be carefully structured so that on the date of conversion from the taxable interest rate to the tax-exempt interest rate the bond is treated as “reissued” for federal income tax purposes. “Reissuance” is a term of art in the tax world, and the rules for reissuance are found in the Treasury regulations at section 1.1001-3. Under those rules, a reissuance occurs when there is a “significant modification” of a debt instrument, resulting in the debt instrument before the modification deemed to be exchanged for a new debt instrument after the modification. The deemed proceeds of the new debt instrument are treated as being used to refund the original debt instrument. Usually, a reissuance is not a result you want to have happen, as it means you have to rethink everything that went into the original determination of tax-exempt status. But in the typical “Cinderella” refunding, the parties want that interest rate conversion to cause a reissuance.

Because a “Cinderella” refunding relies on a reissuance occurring in the future, they present special tax considerations for the issuer. While the conditions present on the date of issuance of the taxable bond will support the later conversion to tax-exempt status, there is no guarantee that on the date of conversion the same conditions will be present. Thus, the issuer’s bond counsel will conduct additional due diligence prior to “blessing” the conversion to tax-exempt status, to confirm that the bonds may be reissued on that date as tax-exempt.

Tender and Exchanges

Finally, tenders and exchanges present another option to issuers looking for new and novel ways to achieve the benefits of a tax-exempt advance refunding. A tender and exchange transaction involves an offer by the issuer to either repurchase outstanding tax-exempt bonds, or exchange the outstanding tax-exempt bonds with new tax-exempt bonds. In either case, the issuer will generally fund the transaction with a series of tax-exempt, current refunding bonds.

The issuer will work with a tender agent to assist it in identifying the holders of the targeted bonds for purposes of making the offer. The tender/exchange process will in some ways look like a typical offering of municipal securities; the issuer will prepare a disclosure document similar to an official statement to assist the holders of the targeted bonds in making the determination of whether to participate in the transaction. A particular transaction may include just an offer to tender the bonds for repurchase, just an offer to exchange, or both. In any event, the transactions are generally funded through the issuance of new, tax-exempt bonds. The offer to repurchase and/or exchange may be conditioned on minimum participation levels.

Issuers may even combine a tender/exchange transaction with a taxable advance refunding. In this structure, the issuer will issue two series of bonds—a tax-exempt current refunding issue, and a taxable advance refunding issue. The proceeds of the tax-exempt issue will be applied to the funding of the tender/exchange portion of the transaction, while the proceeds of the taxable issue will be applied to advance refund any remaining bonds not picked up in the tender/exchange.

While we all hope that the current or a future Congress will pass legislation restoring the tax-exemption for advance refundings, issuers cannot wait for Congress to act. As interest rates continue to rise, we expect that issuers will continue to explore alternatives to tax-exempt refundings to reduce their debt service costs. If you have any questions or would like to discuss alternatives to advance refundings, please contact us.

Timothy J. Horstmann ( and Frannie Reilly ( are public finance attorneys with the law firm of McNees Wallace & Nurick and practice in the firm’s public finance and government services practice group. The firm has Pennsylvania offices in Harrisburg, Lancaster, Pittsburgh, Devon, Scranton, State College and York.