What is Extraordinary Redemption?
An extraordinary redemption is a provision that gives a bond issuer the right to call their bonds due to an unusual event, such as a catastrophe that impacts the source of the bond's revenue. An extraordinary redemption feature must be specified in the bond's offering statement.
Key Takeaways
- An extraordinary redemption is a provision that gives a bond issuer the right to call back bonds due to an unusual event, such as a catastrophe that affects the source of the bond's revenue.
- An extraordinary redemption means the issuer can redeem the bond at par before the bond matures.
- Extraordinary redemption, also called extraordinary call, is most commonly exercised when bond proceeds are not spent according to schedule or a catastrophe affects the financed project.
Understanding Extraordinary Redemption
An extraordinary redemption means the issuer redeems the bond at par before the bond matures due to unusual circ*mstances that impacts the source of revenue. Extraordinary event clauses can be either mandatory or optional, meaning the trigger event can either require the company to redeem the bonds or give the company the option to do so. Terms of an extraordinary redemption must be outlined in the bond's offering statement.
A common circ*mstance under which a bond could be called is a drop in interest rates, which would allow the issuer to refinance by issuing new bonds at a lower rate. This provision may also be used to retire single-family mortgage revenue bonds or mortgage-backed securities when a large number of homeowners refinance their mortgages. Examples of bonds with extraordinary redemption features are water and sewer bonds, housing bonds, and Build America Bonds (BABs).
Extraordinary redemption provisions are found in some municipal bonds. One type of a municipal bond is the revenue bond, which is repaid from the revenue generated from the project it funds. For example, a revenue bond may be issued to fund an airport, with revenue generated from gate fees, charges, and taxes used to service the debt. However, if an adverse event impacts the airport's ability to generate revenue, the issuer could elect to trigger the extraordinary redemption clause.
Extraordinary redemption, also called extraordinary call, is most commonly exercised if:
- bond proceeds are not spent as outlined
- bond proceeds are used in a way that impacts the tax status of the interest earned
- a catastrophe affects the project being financed
Build America Bonds (BABs)
BABs were issued in 2010 as a way of helping municipalities maintain solvency during the economic recession. The government offered issuers and bondholders a 35% subsidy of the interest payments via tax credits, reducing the issuer's borrowing costs and the bondholder's tax liability. If the federal government were to fail to pay the promised 35% of the issuer's interest payments or reduce the subsidy, the extraordinary redemption provision could be activated and the bonds could be redeemed at any time.
In fact, when the government reduced the subsidy from 35% to 28%, some issuers immediately acted and called in high coupon bonds and replaced them with new bonds issued at the lower rate.
Extraordinary Redemption vs. Regular Calls
A regular or fixed call is scheduled and can be exercised by the issuer if interest rates drop to a level that makes bond refinancing financially beneficial to the issuer. The trust indenture lists the call date or dates on which the issuer can redeem the bonds. Bonds cannot be redeemed before these dates.
An extraordinary redemption, on the other hand, is a call option which gives the issuer the right, but not the obligation, to call the bonds when trigger events occur. The bond retirement is unscheduled and can only be called as a result of a certifiable catastrophic event, usually prior to the completion of the project.
FAQs
Extraordinary redemptions allow the issuer to call its bonds in the event of certain specified—and as its name suggests, extraordinary—events, such as damage to the assets collateralizing the debt or the failure of a project the debt was issued to finance. These events are spelled out in the bond's offering statement.
What is an example of an extraordinary call? ›
For example, a mortgage revenue municipal bond may be subject to an extraordinary call if the issuer is unable to originate mortgages to homeowners because mortgage rates have dropped sharply, making the issuer's normally below-market mortgage interest rate suddenly higher than market rates.
What does Xtro redemption mean? ›
An extraordinary redemption means the issuer can redeem the bond at par before the bond matures. Extraordinary redemption, also called extraordinary call, is most commonly exercised when bond proceeds are not spent according to schedule or a catastrophe affects the financed project.
Why do investors not like callable bonds? ›
Callable bonds are more risky for investors than non-callable bonds because an investor whose bond has been called is often faced with reinvesting the money at a lower, less attractive rate. As a result, callable bonds often have a higher annual return to compensate for the risk that the bonds might be called early.
What is an example of redemption? ›
Redemption is the buying back of something. You might try for redemption by attempting to buy back a bike you sold, or you might attempt to buy back your soul after you steal someone else's bike.
What is an extraordinary redemption bond? ›
An extraordinary redemption provision may permit or require the issuer to call all or a portion of outstanding bonds following an extraordinary event that affects the financed project (e.g., a change in use, a condemnation, etc.), or a determination that the interest on the bonds may become taxable, or an event or ...
What is an extraordinary situation? ›
Extraordinary circ*mstances refer to situations that are unusual or unexpected and cannot be predicted or prepared for with normal measures.
What is another word for in extraordinary? ›
exceeding, exceptional, olympian, prodigious, surpassing. far beyond what is usual in magnitude or degree. extraordinaire. extraordinary in a particular capacity. fantastic, grand, howling, incredible, marvellous, marvelous, rattling, terrific, tremendous, wonderful, wondrous.
What is an extraordinary person or thing? ›
If you describe something or someone as extraordinary, you mean that they have some extremely good or special quality. We've made extraordinary progress as a society in that regard.
How do you explain redemption? ›
Redemption means to secure the release or recovery of persons or things by the payment of a price. It is a covenantal legal term closely associated with ransom, atonement, substitution, and deliverance, thus salvation.
Redemption in finance is paying back a fixed-income asset on or before its maturity date. The most popular fixed-income investment is a bond, although there are also CDs, treasury notes, and preferred stocks.
What is redemption in life? ›
“Redemption” means to save; to purchase; to gain possession of something in exchange for a price; or to clear a debt. Jesus' death and resurrection secured redemption for all who would believe in Him (Romans 4:25).
Should I avoid callable bonds? ›
Callable bonds can be called away by the issuer before the maturity date, making them riskier than noncallable bonds. However, callable bonds compensate investors for their higher risk by offering slightly higher interest rates.
Do callable bonds have higher yield to maturity? ›
There are disadvantages to the callable bond holder because the bond proceeds likely would be reinvested in lower-yielding options. Investors are generally rewarded with slightly higher yields relative to a noncallable bond to compensate for the risk of an early call; the amount of extra yield varies, however.
Who benefits from a callable bond? ›
A callable bond allows companies to pay off their debt early and benefit from favorable interest rate drops. A callable bond benefits the issuer, and so investors of these bonds are compensated with a more attractive interest rate than on otherwise similar non-callable bonds.
What does having redemption mean? ›
Redemption is an essential concept in many religions, including Judaism, Christianity, and Islam. The term implies that something has been paid for or bought back, like a slave who has been set free through the payment of a ransom.
What does it mean if someone is beyond redemption? ›
1. : too bad to be corrected or improved. The situation is beyond/past redemption. 2. : incapable of being saved from sin or evil.
What does redemption mean when buying a house? ›
Redemption is a period after your home has already been sold at a foreclosure sale when you can still reclaim your home. You will need to pay the outstanding mortgage balance and all costs incurred during the foreclosure process.
What does redemption mean in life? ›
Redemption (apolutrósis) refers supremely to the work of Christ on our behalf, whereby he purchases us, he ransoms us, at the price of his own life, securing our deliverance from the bondage and condemnation of sin. The New Testament speaks of Christ's saving work in this way frequently.
