What it means
Governments and public bodies issue municipal bonds to pay for projects such as schools, roads and water systems. When interest rates fall, they may want to replace expensive old bonds with cheaper new ones, a process called refunding.
If the old bonds cannot yet be repaid, the issuer must find a way to lock in the saving in the meantime. In a crossover refunding, the issuer sells new bonds today and puts the proceeds into an escrow account, usually invested in safe government securities.
The earnings on the escrow pay the interest on the new bonds. The original revenue stream, such as tolls or utility charges, continues to pay interest on the old bonds until the crossover date.
On the crossover date, which is usually the first date the old bonds can be called (repaid early), the escrow pays off the old bonds. From that moment, the original revenue stream "crosses over" and begins to pay the new bonds.
The old bonds are then fully retired. The structure differs from a standard advance refunding, where the escrow pays the old bonds' interest and principal and the old revenue is released immediately.
In a crossover refunding, the original pledge of revenue stays in place until the crossover date, which affects how investors in each bond view their risk. For investors, the label crossover refunded signals that the bonds are covered by an escrow arrangement for part of their life.
It can mean the bonds are safer than they were when first issued, but the exact protection depends on the terms. Tax rules also affect whether such refundings are available, so they vary by country and over time.
For a finance manager, the key is understanding which revenue pays which bond at each stage. Reading the official statement for the new bonds will show the dates and the escrow arrangements.
In practice
Real-world examples.
Example
A county has water revenue bonds with a high interest rate that cannot be called for three years. It issues new lower-rate bonds and places the proceeds in escrow, so that the saving is locked in before rates change.
Example
A school district uses a crossover refunding for older building bonds. Until the crossover date, local tax revenue continues to pay the old bonds while the escrow supports the new ones.
Example
A bond investor sees that a municipal bond is labelled crossover refunded. She reads the official statement to understand when the escrow will pay off the old bonds and which revenue backs the new ones.
Formula
Calculation
Escrow funding need = Interest on new bonds until crossover date + Principal needed to redeem old bonds
Worked example: a city issues $10,000,000 of new 3% bonds to refund older bonds that become callable in two years. The escrow pays the interest on the new bonds until the crossover date.
Interest until crossover = $10,000,000 x 3% x 2 years = $600,000.
Principal to redeem the old bonds at the crossover date = $10,000,000.
Total escrow funding need = $600,000 + $10,000,000 = $10,600,000, before counting any earnings on the escrow investments.
Because the escrow assets earn interest while they wait, the amount that must be deposited on day one is lower than $10,600,000.Case study
Seen in the real world.
Lakeview Water Authority is a fictional public body, and this case is illustrative only. It had outstanding bonds with a 6% interest rate that could not be repaid for four years, while market rates had fallen to about 4%.
The authority issued new bonds at 4% and placed the proceeds in an escrow account invested in government securities. Water revenue continued to pay the old 6% bonds for four years, while the escrow paid the interest on the new bonds.
At the crossover date, the escrow redeemed the old bonds and water revenue began to pay the new ones. The authority's finance director said the structure secured the lower rate early and gave customers a lower long-term cost, though it required careful legal and accounting support.
Watch out
Common mistakes.
- Assuming the old bonds are paid off immediately, when they stay outstanding until the crossover date.
- Thinking the escrow pays the old bonds' interest, when in a crossover refunding it usually pays the interest on the new bonds.
- Forgetting that rules on tax treatment can change what refunding structures are available.
Questions
People also ask.
What does the crossover date mean?
It is the date on which the escrow redeems the old bonds and the original revenue starts to pay the new ones.
How does it differ from an advance refunding?
In an advance refunding, the escrow typically pays the old bonds directly and the old revenue is released, whereas a crossover keeps the original revenue pledged until the crossover date.
Why would an issuer use it?
It lets the issuer lock in lower interest rates before the old bonds can be called, while keeping the original revenue pledge in place.
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