June 2002: Advance Refunding Bonds

Issued To: School District and BOCES Business Officials

Purpose of Bulletin

This bulletin explains the reporting requirements for advance refunding bonds. Many school districts are issuing advance refunding bonds this year because the state is changing how it calculates and pays building aid. Building aid, rather than being based on actual debt service payments, will now be based on an "assumed amortization calculation" that assumes that districts borrow money for the maximum period of probable usefulness allowed by Local Finance Law section 11.00 and pays an assumed interest rate. Details are on the State Education Department's website.

What are a "current refunding" and an "advance refunding"?

In a current refunding, the proceeds of the refunding bonds are used currently (immediately) to redeem the old debt. In an advance refunding, the refunding bonds are issued "in advance" of the actual redemption and placed in an escrow account pending the call date or maturity date of the old debt.

Why do a debt refunding?

A debt refunding is usually done to extend the payout of the debt to the maximum legal limit (A project with a period of probable usefulness of 25 years that was financed over 15 years is extended by 10 years to stretch-out the payments) or to achieve a present-value savings (A time-value analysis of the stream of debt service payments is done on the outstanding bonds and the proposed advance refunding bonds to determine whether there's an economic savings) usually because of lower interest rates.

How is an advance refunding done?

In an advance refunding, bonds are refinanced (paid off) by issuing new bonds. Typically, the proceeds of the new bonds are placed in an escrow account (in a bank or trust company located and licensed to do business in New York State). After payment of issuance costs, the proceeds are used by the escrow agent to purchase special United States Treasury securities (generally directly from the Bureau of Public Debt, Division of the U.S. Treasury Department). The escrow agent uses the principal and interest collected on these to pay the outstanding "refunded" bonds. The refunded bonds, if they are callable, are subsequently (on their call date) "called" for early maturity prior to their stated maturity date. If the bonds are not callable, they can still be advance refunded, but the escrow account is established to pay debt service on the refunded bonds on each bond maturity date rather than an earlier "call date".

How is an advance refunding reported in financial statements?

The debt service fund reports revenues and expenditures equal to the bond proceeds (See Form ST-3):

Revenue Account V980-5791 Proceeds of Refunding Bonds
Expenditure Account V522-9991.4 Payment to Escrow Agent

If local funds are used to pay closing costs, the debt service fund reports:

Revenue Account V980-5031 Interfund Transfer
Expenditure Account V522-1380.4 Fiscal Agent Fees
Expenditure Account V522-9991.4 Payment to Escrow Agent

The Statement of Non-current Governmental Liabilities, which is the new schedule for the Long-term Debt Account Group, should report the new debt, but not the old debt.

How is debt service paid on the refunded bonds?

Debt service payments on the refunded bonds are paid directly from the escrow account. These are not included in the school district budget.

What Notes to Financial Statements are needed?

Audited statements should include a footnote using the following examples as a guide:

In the year the advance refunding takes place:

Note X: General Long-term Debt

On (month, date, year), $ xx.x million in general obligation bonds with an average interest rate of x.x percent were issued to advance refund $ xx.x million of outstanding bonds with an average interest rate of x.x percent. The net proceeds of $ x.x million (after payment of $ x.x million in underwriting fees, insurance, and other issuance costs) were used to purchase U.S. government securities. Those securities were deposited in an irrevocable trust with an escrow agent to provide for all future debt service payments on the bonds. As a result, the bonds are considered to be defeased and the liability for those bonds has been removed from the financial statements. This refunding (increases) (decreases) total debt service payments over the next xx years by almost $ x.x million resulting in an economic (loss) (gain) (difference between the present values of the debt service payments on the old and new debt) of $ x.x million.

In years following an advance refunding in which the old debt is still outstanding:

Note Y: Prior-year Defeasance of Debt

In prior years, certain general obligation bonds were defeased by placing the proceeds of new bonds in an irrevocable trust to provide for all future debt service payments on the old bonds. Accordingly, the liability for the defeased bonds, $ xx.x million, and the trust account assets are not included in the financial statements.