Serial Bond Definition

Serial bonds, unlike bullet or term bonds that repay the entire principal at the time of maturity, repay it in installments at regular intervals, i.e. the entire issue consists of multiple securities or CUSIP of varying maturities and each such CUSIP or a bunch of CUSIP number matures at a different time according to a repayment schedule specified in the bond indenture.

Generally, these are issued by center, state governments or municipalities to finance large public works projects, such as highways, toll roads, flyovers, schools, etc. The projects require huge investment at the initial phase and after these projects start generating revenues, a consistent and regular stream of cash flow is expected. These revenues are used to pay off the debt, therefore they are sometimes also known as revenue bonds.

In comparison to amortizing bonds, which consist of a single maturity bond, a Serial bond issue consists of multiple maturity bonds. In amortizing bonds a part of every payment consists of principal and the remaining part of interest, while for serial bonds, the principal is repaid on specific dates.

Example of a Serial Bond

The following are examples of serial bonds.

Example #1

Let us suppose that the issuer issues serial bonds worth $10 million on 1^st January 2010 at 10% annual interest payable on December 31^st every year. The issuer also specifies the following repayment schedule:

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Following inferences can be made from the table above:

Till December 31st, 2014 entire $10 million is due to the annual interest is $1 million
Till December 31st, 2015 entire $10 million is due to the annual interest is $1 million, however, on this date, $2 million is redeemed leaving the balance of $8 million, for the years to come
On each subsequent December 31st, $2 million is redeemed reducing the balance by $2 million, for the years to come and thereby reducing the interest expense accordingly

Example #2 – County of Ulster

As mentioned earlier, Municipalities are one of the issuers of serial bonds and are governed by the Municipal Securities Rulemaking Board (MSRB) in the US. They have an electronic database of the bonds issued by them which contain all the information on their serial bond issues as well. This database is called Electronic Municipal Market Access (EMMA).

Serial bond issues can be accessed on this website: emma.msrb.org

This website also contains detailed official statements released by the issuers on several such issues, which give information such as the repayment schedule, taxability of the issue, present financial position of the issuer, companies or institutions which are liable to pay off the issues, etc. Following is one such issue:

County of Ulster, New York Public Improvement (Serial) Bonds

In this issue, general obligation serial bonds worth $5,280,000 were issued as per their official statement dated August 1^st, 2019 for improvements of public real estate.
These will become due for redemption on November 15, 2019-2027, and are not subject to redemption prior to maturity, i.e. any date before and the principal redemption schedule is as follows:

Source: County of Ulster, New York Public Improvement (Serial) Bonds: official statement dated August 1st, 2019

The securities under this issue are of denominations of $5000 each
A purchase will be made on the book-entry system only, i.e. there will be no physical transfer of bond, only transfer entries will be made in the books of Depository Trust Company (DTC) and direct/indirect participants.
The county will generate revenues by levying taxes on real estate within the procedures, limitations, and formula set forth by the “Tax levy limitation law”
The revenue so generated is transferred down the chain through DTC for payment of interest and principal
Following is the flow of securities and cashflow

The County spreads the word that the bonds are being issued, and this is trickled down to bondholders via a chain of DTC who in turn inform the direct/indirect participants
Prospective bondholders approach their nearest participant and express their interest in purchase and deposit funds for the same
Participants convey the word up the chain
The county is responsible to deliver the securities down the chain
The same chain is followed for interest and principal payments
This flow is maintained to achieve deeper penetration of securities

Advantages of Serial Bonds

Lowers default risk: As the principal is repaid in installments at regular intervals, not the entire amount becomes due on one single date, and therefore it reduces the instances of default with each such repayment by reducing the impact of unforeseen future events which might lead to unavailability of large sum on the single maturity date.
Attracts more investors: Investors with different time horizons can invest in these bonds depending upon their investment needs, therefore these bonds are lucrative for a wider pool of investors. Further, the interest rates also vary shorter maturity bonds have lower interest rates, while longer ones have higher interest rates to compensate the investor for undertaking higher risk.
Reduced cost of debt: Issuers prefer these as they reduce interest liability with each principal repayment date. This leads to a lower weighted average interest cost in comparison with a bullet bond.

Disadvantages of Serial Bonds

Reinvestment risk: Although these reduce the default risk for the investors, they create reinvestment risk if the interest rate environment is declining. Investors may need to make use of derivative contracts such as forward rate agreements, or swaps or options to hedge against such fluctuation in the interest rates, which is an additional cost, or may bear the reinvestment risk.
Inappropriate for some projects: These should be issued only for the projects which generate consistent and regular cash inflows to pay off the principal installments and if such projects face a certain setback, they lead to piling up of obligation very early in the project

Conclusion

To sum up, the striking feature of the serial bonds is the repayment schedule, which makes it appropriate for investors of different time horizons. These bonds are issued mainly by the government to fund projects which will provide regular income in the future, which is used to repay the debt of the issue. There can be corporate issues too but that’s not very common.

They pose a trade-off for the investors between the default risk and the reinvestment risk whereas the trade-off for the issuers is in terms of lower interest rate and earlier principal repayment.

Serial Bond