Advance refunding of municipal bonds threatens future value

The tendency among municipal issuers to call their bonds early in the belief they are refunding on better terms often results in the loss of future value, to the detriment of the taxpayer.

Municipal bonds make up a sizeable portion of the US fixed income market, with around 50,000 issuers accounting for close to $3 trillion of outstanding debt. Unlike the corporate bond market, where the call option is approaching extinction, most long duration tax-exempt municipal bonds are callable after 10 years. The call option allows issuers to take advantage of declining interest rates by issuing new bonds at lower yields and paying off the outstanding bonds at the call price.

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