Also referred to as “Pre-Res.” pre refunded municipal bonds are those that are backed by an escrow account, invested in US Treasuries, which is used to pay bondholders.
Often times when interest rates drop below the amount a bond was yielding when it was originally issued, the issuer will call the bond. This means that they will issue new bonds at the lower interest rate, and use the proceeds to pay off the existing bonds with the higher interest rate. You can learn more about callable bonds here.
However, most bonds have a specific date in the future where, until that date is reached, the bond cannot be called. This is where pre refunded municipal bonds come into play. When an issuer wants to take advantage of lower interest rates, but is not able to call the existing bond issue, they will issue new bonds and place the proceeds in an escrow account which is used to pay off existing bondholders when the bonds can be called.
Once a bond issue has been Pre Refunded, the obligation to pay is on the escrow account. As the escrow accounts are funded with US Treasuries, Pre-Res are often seen as safer than than they would be without being Pre Refunded. This can therefore result in a positive credit rating change for bondholders, and often results in a price increase for existing bondholders.
For the definition and explanation of more bond related words visit the Learn Bonds glossary where we give the meaning of many additional terms.