Policy Changes and Management
Studies in Fiscal Federalism and State–local Finance series
Chapter 10: Reducing debt service by refunding debt
This chapter provides an overview of one of the major purposes of the sale of municipal securities: to refinance bonded and non-bonded indebtedness. The chapter begins with a discussion of the purposes and types of debt refinancing. It proceeds to detail the basic analytics behind debt refinancing, and examines four principles that undergird prudent debt refinancing strategies. The chapter concludes by offering some policy recommendations for subnational governments in their debt refinancing practices. The primary reason subnational governments sell debt is to provide capital financing for projects such as the construction of roads, schools, government buildings, airports, water and wastewater systems, to name just a few typical capital projects. This debt is often structured such that the final maturity on these bonds can be decades into the future with the subnational government retiring the debt incrementally each year. Between the issuance date and final maturity on the bonds, economic conditions, operational position and policy/political preferences can change, necessitating the need to consider refinancing outstanding debt obligations. There are three reasons for a state or local government to refinance or refund its bonded indebtedness (Wood, 2008). The most common reason is to take advantage of lower interest rates, which produces interest cost savings compared to the interest paid on the previously issued bonds. This type of refunding is known as an economic refinancing whereby the government replaces higher interest rate bonds with lower interest rate bonds.
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