Serial bonds are bonds issued at the same time but with different maturity dates. A serial issue of bonds might, for example, have half the bonds mature in 10 years, 25% of the bonds mature in 15 years, and the last 25% mature in 20 years. Maturity dates of serial bonds will be listed in the offering documents.
Why Issue Serial Bonds?
A serial bond issue is an effective way for an issuer to bring in substantial capital up front while getting out of debt quicker than they might with an issue of bonds that all mature at once.
Because the risk of default will decrease as time goes on, serial bonds are perceived to present less credit risk than bonds that all mature at the same time. This usually means that rating agencies will give serial bonds higher ratings. Issuers desire high ratings because highly-rated bonds are more attractive to investors, and also because the higher a bond is rated, the lower the coupon rate is. The lower coupon is a tradeoff for the higher degree of safety, and of course, a lower coupon rate will save the issuer money on their interest payments.
Sinking Funds vs. Serial Bonds
Serial bond issues and sinking funds are alike in that their objective is to reduce the amount of outstanding debt from a bond issue over time. There are some key differences between the two strategies, though.
As explained earlier, serial bonds are issued at the same time, with groups, or ‘tranches’ of bonds maturing at different times that are set forth in the issue document. With the maturity of each tranche comes a reduction in the issuer’s outstanding debt.
Bonds with a sinking fund are issued at the same time and mature at the same time. The sinking fund is established by the bond’s trustee, and the issuer makes periodic payments to the sinking fund. The trustee uses the sinking fund to purchase existing bonds on the open market, effectively retiring them on behalf of the issuer.
Serial Municipal Bond Issues
Serial bond issues are very common for municipalities. This is because municipal bonds are frequently issued to fund income-generating projects for cities and states.
A municipal bond might, for example, fund the building of a football stadium that makes money from parking fees and admission charges. The issuer will likely believe that the stadium will generate consistent income for several years, so they can structure the maturity dates to be serial and gradually reduce their outstanding debt.
To those considering municipal bonds for retirement planning, remember that municipal bonds are tax-free at the federal level, so holding a municipal bond in a retirement planning account such as an IRA usually provides no additional tax benefit.
Municipal bonds are most appropriate for investors in high income tax brackets. As a tradeoff for the tax-free interest, municipal bonds typically have lower coupon rates than comparable corporate or treasury bonds. This makes the tax savings most significant for those who would otherwise pay a substantial amount in taxes on interest income.