B.1.5.3 Refunding Bonds
Refunding bonds are issued by districts to refinance an existing issue of bonds with a new issue of bonds (see Section 3.7.6 Refunding Bonds). The term can include bonds, notes, or COPs. In a refunding, the proceeds of the refunding bonds are used to pay the existing or “refunded” bonds, either at maturity or, if the refunded bonds are subject to optional redemption before maturity, at an earlier redemption date. When an issuer undertakes a refunding they are essentially refinancing their debt, like refinancing a home mortgage.
School districts use refundings to take advantage of favorable interest rate environments, to amend/remove restrictive bond covenants, and/or to restructure debt service payments. The benefits to the local agency of issuing refunding bonds to refund GO bonds are indirect because any debt service savings must be passed on to taxpayers rather than retained by the issuing entity. Overall savings are not necessarily an immediate savings or a lower tax rate; rather, the savings are realized over time or by the final maturity.
California school districts can issue new money bonds under different statutory provisions including the education and government codes. Refunding bonds can be issued by all public agency issuers pursuant to Government Code Section 53550, referred to as Article 9, and 53580, referred to as Article 11. Refundings involving voter approved debt do not require additional voter approval because they use existing voter authorization. The refunded debt is considered a change in the form of indebtedness, not an increase in additional outstanding debt. A refunding is a variation on basic financing techniques because the proceeds of the refunding bonds are applied to the payment of the refunded bonds rather than the costs of a project. It is not uncommon for refunding bonds and capital project bonds to be sold at the same time by an issuer. Any costs of issuance paid from sources other than refunding bond proceeds (and interest earned thereon) must be added to the costs of the refunding bonds.
Refundings are subject to a complex set of arbitrage and rebate requirements and restrictions under the Internal Revenue Code. Issuers should understand these requirements and would be best served meeting with counsel before considering a refunding to address these requirements (see Section 4.12 Refunding Bonds). Under the Internal Revenue Code, refundings are classified as either “advance refundings” or “current refundings.”