Municipal Bond Forum
Escrowed-to-maturity bonds
Q
It appears to me that many bonds that are escrowed to maturity have yields significantly higher than those that are not escrowed. I have asked several local bond folks for an explanation and really haven’t gotten one that makes sense to me. I have to believe that higher yield means greater risk, but I am not clear as to what creates the apparent increased risk in these escrowed bonds. Can you help?
A
James A. Klotz responds:
It is difficult to give you a precise answer without being aware of the specific bonds you are referring to. Here are a couple of possible explanations for what you are experiencing.
Escrowed-to-maturity bonds, issued many years ago with larger coupons, can trade at substantial dollar prices. They often need to be priced with higher yields in order to make them more marketable.
A more likely explanation is that even though some bonds have been escrowed to maturity, the issuer retains the right to call them prior to maturity.
Although these bonds are not usually “priced to the call,” the fact that calls have not been “defeased” could account for the higher yields. This is a controversial practice and could result in a negative return if bonds are called.
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