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Positive Arbitrage – It’s Back

Positive Arbitrage – It’s Back

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Earning positive arbitrage becomes more likely as interest rates rise. That is good news for tax-exempt bond issuers because interest earnings can become a more legitimate contributor to project budgets. But it also means paying closer attention to arbitrage rebate strategy. At the moment, there are two critical categories of potential issues to consider:

  • New bond issues with lower borrowing rates (arbitrage yields) that are earning positive arbitrage or will soon earn positive arbitrage. Good credits and short-term borrowings are the most vulnerable. Any debt obligation with a bond yield of roughly 3% or less has an opportunity to earn positive arbitrage based upon current and reasonably expected market conditions.
  • Bond issues from 2014 to 2016 with unspent balances in project funds. If not previously waived, the 3-year temporary periods will expire in this higher interest rate environment. Issuers that waived temporary periods in 2014 to 2016 likely made a great strategic move.

Waiving the Temporary Period

Even with rates rising, it may still make sense to consider waiving the 3-year temporary period on new project funds. The table below outlines considerations for whether this is a conversation worth having with bond counsel.


Note that the considerations are based on current market conditions and current expectations for borrowing rates (arbitrage yields) and investment rates for bond proceeds. Remember that evaluating whether or not to waive the temporary period is a conversation to have with bond counsel prior to issuance. It is a tax election that must be made in writing at settlement and cannot be changed thereafter.

Spending Exceptions – Use It or Lose It

Monitoring spending of new money bond proceeds is becoming more important. The spending exceptions are generally deemed an incentive from the IRS that allow issuers to keep positive arbitrage if they spend bond proceeds quickly. In addition, unspent bond proceeds have been a topic of interest with the IRS, so the timely expenditure of bond proceeds is vital.

Municipal issuers have to spend proceeds (and interest earnings) based on prescribed six-month benchmark spending requirements to meet one of the exceptions (see chart on page 2). Because there is no catch-up provision, once an issuer misses a spending benchmark, the ability to meet the exception is lost.

Here are some strategies to monitor and mitigate potential risks


  • Engage a rebate analyst now, even for new bond issues. 5th year reporting is a must; annual reporting is better especially while proceeds are outstanding.
  • Talk to your rebate analyst and financing team in advance of pricing to discuss strategy and tax implications of your deal.
  • Review to make sure bond proceeds are not only invested, but invested wisely. Bond proceeds sitting in uninvested cash could be earning retainable interest1.
  • When doing a refunding, talk to your rebate analyst about preparing final arbitrage reports.
  • If you issued new money debt in 2014-2016, review unspent project fund balances, and determine if temporary periods have expired or will be expiring soon.
  • Schedule arbitrage rebate calculations to prevent exposure to unnecessary risk.

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