When bonds are advance refunded, a verification agent confirms that enough money has been set aside in escrow to pay interest and principal on the original refunded bonds.
In an advance refunding, interest rates drop before outstanding bonds may be called and paid off early. To nevertheless “lock in” savings from the lower rates, new bonds are issued, and the proceeds from the new bonds are put into an escrow account. In most advance refunding arrangements, the money in the escrow is used to pay periodic interest on the existing bonds, plus principal when the original bonds eventually reach their call date and are redeemed.
The proceeds from the new bonds in the escrow are invested in very low-risk securities, such as State and Local Government Securities (SLGS) offered by the federal government. Although these securities typically have low yields, they nevertheless earn some income. With this investment income, the issuer needs less in proceeds from the new bonds than will be needed to pay interest and principal on the original bonds.
A verification agent – an independent third party, such as a CPA firm – mathematically calculates and verifies that the money in the escrow will be enough to make principal and interest payments on the existing bonds.
