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What is the Role of the Escrow Agent?

Written by Debtbook Team | Apr 1, 2024 7:05:05 PM

When an issuer executes a refinancing of outstanding bonds (also called a refunding), it usually sells new bonds whose proceeds go to pay off the old bonds. The proceeds from the new issuance are used to purchase securities whose maturities match the principal and interest dates of the old bonds. These securities are then placed in an escrow account.

The escrow agent, typically a commercial bank, is responsible for holding and managing the securities in the refunding escrow account up to and including the date when the refunded bonds are redeemed.

The escrow agent cannot make payments to an investor unless the issuer verifies the payment. On the date the securities are given to the escrow agent, they also receive written instructions on what to do with both the securities and the interest on the securities.

Escrow agents can also be retained to hold any other securities purchased with bond proceeds and are given instructions on how to spend the principal and interest from the securities in the future. In some accounts, the issuer can ask the escrow agent to sell securities early if it needs the money earlier than expected.

Example:

An issuer executes a Series 2023 refinancing on January 1, 2023 of the Series 2013 bonds, which were issued to fund a project. The old bonds are callable on April 1, 2023. This means that the bond proceeds from the Series 2023 bonds are going to be invested for 90 days until they will be used to call the Series 2013 bonds. An escrow agent is hired by the issuer and instructed to hold the securities until they are used to refinance the Series 2013 bonds and directed how to reinvest should a security mature prior to its cash being needed.

What’s important here?

An escrow agent’s responsibility is to execute the issuer’s wishes regarding securities purchased by the issuer to complete the financing. The escrow agent is given an initial set of securities and instructions by the issuer on how to spend any interest or principal from the securities, and directed how to reinvest any money that is not used immediately towards the financing.