A Ratchet Bond is like a conventional floating rate bond, but its coupon can be reset only downward. TVA issued two of these structures with 30-year maturities, totaling over $1 billion in size. Over the last six years, the coupon on the first issue has declined from 6.75% to 5.46%; the second from 6.50% to 5.17%. Because of the Ratchet Bonds automatic reset feature, TVA reduced its interest expense without incurring the customary fees associated with tapping into the capital markets.
âRatchet Bonds can be a debt managerâs lifeline in stormy markets,â says Dr. Andrew Kalotay, president of Andrew Kalotay Associates, who helped TVA with the first Ratchet Bond issue in 1998. âBy relying exclusively on callable bonds, federal agencies, corporations, and municipalities are missing out on the benefit of todayâs record-low Treasury yields.â
Dr. Kalotay also points out the considerable expense borne by issuers from recurrent calling and refunding cycles. For example, in the second half of December alone, Freddie Mac called more than 700 issues totaling $29 billion. The associated reissuance cost, even by conservative estimates, exceeds $50 million.
âRatchet Bonds are superior to callable bonds in two significant ways,â he says. âTheir coupons decline in tandem with Treasury yields (or benchmark rates) regardless of the credit environment. In addition, Ratchet Bonds eliminate the ongoing reissuance expense associated with refunding callable bonds.â