County finance adviser outlines options for excess bond proceeds, recommends defeasance to reduce outstanding debt

Tom Grama, of Colliers, advised the Clay County Board of Commissioners on options for handling unspent proceeds from a prior bond issue, saying the county could place the surplus in an escrow to defease a portion of the outstanding bonds and thereby reduce the debt shown on its books.

Grama said technical defeasance involves putting funds into an escrow account whose earnings pay debt service on the defeased bonds until the bonds are callable, and that the transaction "reduces the amount of debt outstanding" without immediately allowing the county to spend the cash elsewhere. He estimated that, on a hypothetical $7,000,000 of surplus, a defeasance could remove about $6,565,000 from the outstanding balance and generate net present-value savings in the hundreds of thousands of dollars based on current market rates.

Why it matters: Defeasance can produce immediate budgetary and accounting benefits by shortening the county's shown debt and lowering future annual debt service; but federal tax rules limit use of proceeds and interest earnings from tax-exempt bond issues.

Details and limits

Grama told the board that tax rules for the federal tax-exempt bond market restrict how the county may use excess bond proceeds and any interest they earn. "If you issued more than $5,000,000 of bonds," he said, "if you earn more interest on that, that money needs to be rebated back to the federal government." He added that because of those rules, simply holding surplus proceeds in a county account usually does not provide a net financial benefit compared with setting up an escrow for defeasance.

Grama explained timing constraints tied to call dates. For the bonds under discussion, portions are not callable for several years, so any defeasance would pay interest in escrow until the applicable call date; at that point the escrowed bonds could be refunded and removed from the county's outstanding debt schedule. He also described the modest negative arbitrage risk if escrow yields are lower than the bond coupon, noting an example loss on the order of tens of thousands of dollars in his illustrative case.

Next steps and procedure

Grama said a formal resolution by the board and engagement of bond counsel would be required to proceed, and Colliers would charge a nominal engagement fee. Commissioners indicated they would await final construction closeout numbers before deciding; Carrie and Travis (county staff mentioned during the discussion) said the final bills would clarify the exact surplus available. No formal county action on defeasance was taken at the meeting; Grama left the board with an illustrative analysis and said he would work with county staff when the final numbers are available.

Ending

County staff and the board agreed to review updated final project bills and the defeasance analysis before taking a resolution to engage counsel or to set up an escrow. Grama recommended defeasance as the safest way to reduce on-paper debt while respecting federal bond rules.