What Is a Catastrophe Call?

A catastrophe call is a call provision in municipal bonds that allows for the early redemption of the instrument if a catastrophic event occurs andꦐ severely damages the project financed by the issue. Possible catastrophes will b✤e listed in the bond's indenture and are often callable at par.

It is a type of 澳洲幸运5官方开奖结果体彩网:extraordinary redemption provis🅺ion used to offset lost revenue from a municipal bond that was issued to fund the construction of a community facility that later suffers significant damage, limiting its ability to generate revenue to repay the bond.

These should not be confused with a 澳洲幸运5官方开奖结果体彩网:calamity call, which is a protective measure for investors in a 澳洲幸运5官方开奖结果体彩网:collateralized mortgage obligation (CMO) that is triggered if defaults or prepayments on the underlyi🌌ng mortgages threaten to interrupt the cas🍎h flow generated by the investment.

Understanding Catastrophe Calls

Catastrophe calls provide municipalities insurance against natural disasters. For example, let's say an earthquake destroyed a newly constructed bridge. Since the construction cost was financed by a municipal bond issue (with a catastrophe call option) and the bridge's destruction does not allow it to generate the revenue expected to repay the debt, the bonds may be called at par immediately. Since bonds with catastrophe call provisions carry a higher risk load for the issuer, they also generally have a higher yield than 澳洲幸运5官方开奖结果体彩网:general obligation (GO) bonds to account for the risk factor.

It is not advantageous for all municipal bonds to issue a catastrophe call provision, but catastrophe call provisions are more common in 澳洲幸运5官方开奖结果体彩网:revenue bonds. Revenue bonds are a specific type of municipal bond that are issued to finance specific projects that will, in turn, produce thei🔯r own revenue. The thought is that in issuing these types of bonds, the project's revenue stream will pay back the bond. Furthermore, revenue bondholders typically do not have a financial claim to the cꦅompleted project assets.

For example, an institution that issued a revenue bond for a toll road is not able to then repossess the toll road in th🎉e event that it does not produce the expected and agreed-upon revenue to pay the interest and principa💯l payment.

Catastrophe Call Example

Consider the following scenario: The City of Pleasantville wishes to build a new toll road due to its position as 🌌a major pass-thrꦛough for travelers during the summer months. However, the City of Pleasantville does not possess the necessary funds needed to construct the toll road.

In order to finance the road's construction, the municipality issues revenue bonds to its residents for fund generation, with the plan that the collected tolls will then pay the payments and interest on the bonds over a term of 30 years, as set in the bonds agreement. Because the City of Pleasantville also happens to be located near a fault line, the revenue bonds contain a catastrophe call provision, which the investors are aware of.

Three years after the project is financed and the toll roads are constructed, an earthquake hits the City of Pleasantville and the toll roads are affected by the natural disaster. The earthquake qualifies under the catastrophe call provision, which means that the City of Pleasantville is eligible to call its bonds. Calling the bonds allows the city to pay off the bonds immediately instead of waiting for the original life of the bond, subsequently averting any remaining portion of the bond's interest earnings.