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Opportunities for Municipal Borrowers

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Interest rates are historically low. The anticipated date for the eventual rise in rates has not been formally set by the Fed, and seems to be regularly postponed.  Low interest rates present a challenging investment climate for municipalities, hospitals, school districts and colleges or universities. But it’s not all gloom and doom. There are options in which these entities may meet the challenges and seize the opportunities that come from low interest rates when they issue municipal bonds.
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The Challenges and Opportunities in the Current Marketplace
Let’s say you are a university finance officer and you need to underwrite $10 million in order to build a new library. You raise the $10 million via a new bond issue but the project calls for the cash outflow for the new building construction to happen throughout the next 24 months.  This means you have to invest the currently unspent balances in the meantime. Given the current low interest rate environment, the rate you receive on the invested balances will likely be lower than the rate you paid to raise the debt.

This situation, called negative cost of carry, occurs when an entity issues debt and then invests all or a part of the proceeds at a rate lower than the rate being paid on the debt issued.  Examples of this would include: project construction funds, escrow funds to redeem refunded bonds and debt service reserve funds where not all of the proceeds are immediately used. The interest rate on the bonds, or the borrowing rate, may be substantially higher than the rate which may be earned on proceeds, resulting in a negative cost of carry. Like our library example, if you do an underwriting for $10 million and pay an average of 3 percent interest on those bonds, in many cases, all of your proceeds aren’t put to use immediately for a building or project. Therefore, you would have $10 million in cash for a period of time. Rather than sitting on that cash and earning nothing, you’d probably invest the $10 million. However, since interest rates are so low, you wind up investing the cash you are paying 3 percent interest on into something yielding far less.

While the low return on invested proceeds can create a drag on the financing of the project as the current market provides a substantial tail wind with the low interest rate on the issued bonds. This opportunity is most apparent with refunding bonds. Unlike the corporate bond market, the municipal bond market typically allows issuers to embed the right to prepay without penalty on their long-term fixed rate bonds. Issuers can see substantial savings in interest costs by issuing new debt and using the proceeds to redeem, or prepay, the old, higher rate debt on the call date. In 2014, refunding bonds represented nearly 41 percent of all long term municipal issues, up from 33 percent in 2013. We believe this trend will continue in 2015.

Gain Better Timing and Rates through Private Placement
Private placements can be another great alternative to traditional public issues, which might result in negative cost of carry.

Let’s go back to our example of the new university library. Instead of the debt being sold in the public markets, it could be privately placed with one or a small accredited group of investors to allow for additional flexibility as it relates to the structure of the debt. Instead of the university having to deal with negative cost of carry for two years as indicated above, it could instead structure the debt so that it drew the cash in accordance with the construction timeline, potentially lessening the impact of negative cost of carry in a low interest rate environment.

A growing number of issuers have captured the low borrowing rates and then addressed the interest rate gap between the cost of issuance and rate they are able to invest at by structuring issues in the private placement market which offer more flexibility. As private placement purchasers appetite for debt has increased, the spread between publicly issued debt and privately placed debt has decreased, making it an attractive proposition. Here are other possible advantages to private placements:

  • Private placement purchasers, frequently commercial banks, are currently offering attractive borrowing rates not far removed from rates bid for publicly-offered issues.
  • Private sales avoid the time-consuming and costly work of preparing the disclosure documents required to publicly offer the bonds.
  • Issuers will not be required to observe the continuing disclosure rules of 15(c)(2)12 of the Securities Act.
  • Private placements are not registered with the SEC, so registration and disclosure requirements like the Municipalities Continuing Disclosure Cooperation Initiative are not required.
  • Credit ratings, bond insurance and printing costs can all be eliminated with private placements.

Another Advantage: The Draw Feature
In addition to the ease of issuance, only private placements can offer a valuable alternative called the draw feature. At settlement, the initial draw is used to pay cost of issuance, the remaining bond proceeds are paid to the issuer when needed rather than at settlement. Interest will not accrue on the bond until, and only to the extent that, proceeds are drawn. Construction project financings greatly benefit from the draw bond structure. For instance, a $10 million construction project that is financed at 4.00% over 20 years and takes two years to complete, would generate an estimated savings of $380,000 when financed with a draw bond.  Interest would accrue on approximately $5 million on average over the two year construction period, or $400,000 of interest, instead of $800,000 of interest accruing on the full $10 million over the same period with a public sale. The public sale would permit approximately $20,000 of interest earnings on the project pending disbursement.

Draw bonds provide similar efficiencies for refunding bonds. For example, assume an outstanding $10 million bond yielding 4 percent which may be called in one year. The delayed draw refunding bond paying 2.50 percent will reduce the size of the escrow requirements and avoid the negative investment earnings in the escrow. These efficiencies result in over $300,000 or 2 percent of the bond size in additional estimated savings compared to a publicly-issued bond in which proceeds are held in escrow and invested during the one year escrow period.

However, what if the issuer has an outstanding bond which may not be called for several months, and has already been advance refunded? The delayed draw structure can be used effectively to lock in today’s low rates on the refunding bonds and still comply with the restrictions on no more than one advance refunding. The privately placed, delayed draw bond simplifies what might be addressed in a public issuance with complicated and expensive swaps and derivatives.

Final Note
It is important to consider that while the new developments in the private placement of municipal bonds may provide the issuer with more flexible and efficient alternative financing options, current interest rates and uncertainties can be tough for institutions when managing these strategies.

Keep in mind, there are a number of sensible and intelligent ways to take advantage of any economic situation.

The information and opinions expressed in this message are solely those of the author and do not necessarily state or reflect the opinion of UMB or UMB Financial Corporation. 

disclosure

When you click links marked with the “‡” symbol, you will leave UMB’s website and go to websites that are not controlled by or affiliated with UMB. We have provided these links for your convenience. However, we do not endorse or guarantee any products or services you may view on other sites. Other websites may not follow the same privacy policies and security procedures that UMB does, so please review their policies and procedures carefully.


Mr. Philip Richter is a Senior Vice President for UMB Bank. He is the Manager of the Public Finance Department in the Investment Banking Division. Phil joined UMB in 1997 and has over thirty years of experience in the municipal bond and financial services industry.



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Financial Word of the Week: 401(k) Plan

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Financial Word of the Week

A 401(k) plan is a retirement savings account usually offered through your employer. Some employers will offer a match or non-elective contribution to your retirement account, which is a smart way to help you reach your retirement goals faster.

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It’s important to understand the plan your company offers to ensure you are getting the full employer match by contributing as much as you need to be. Remember, your employer’s contribution match is free money!

The contribution you elect to make is taken out of your salary before taxes. The IRS regulates how much you can contribute each year. For 2015, the limit is $18,000. If you are 50 or older (and therefore closer to retiring), you can contribute an additional $6,000 as a catch-up contribution. 401(k) contributions are usually invested in mutual funds, which will be covered later in our series. Generally, a 401(k) account cannot be accessed until you are 65 without early withdrawal tax penalties.

Use our calculator to obtain an estimate of where you stand with your retirement savings.

If your employer doesn’t offer a 401(k) plan, stay tuned for next week’s post when we explore other retirement savings account options.

 


UMB Financial Corporation (Nasdaq: UMBF) is a diversified financial holding company headquartered in Kansas City, Mo., offering complete banking services, payment solutions, asset servicing and institutional investment management to customers. UMB operates banking and wealth management centers throughout Missouri, Illinois, Colorado, Kansas, Oklahoma, Nebraska, Arizona and Texas, as well as two national specialty-lending businesses. Subsidiaries of the holding company include companies that offer services to mutual funds and alternative-investment entities and registered investment advisors that offer equity and fixed income strategies to institutions and individual investors.



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First Quarter 2015 Earnings Explained

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We recently released our First Quarter 2015 earnings. Our CFO, Brian Walker, took a moment to explain where we faced headwinds as well as the positive aspects of the last quarter.


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Mr. Walker is the Chief Financial Officer and Chief Accounting Officer at UMB Financial Corporation. He joined UMB in 2007. He earned a Business Administration (Accounting) degree at Kansas State University and his Masters of Business Administration degree at Rockhurst University. In addition to his involvement with several community and charitable organizations, he is also the treasurer for the Big Bash Foundation, a not-for-profit foundation focused on providing financial assistance and increasing visibility for local not-for-profit organizations.



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Financial Word of the Week: HSA vs. FSA

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Financial Word of the Week

You’ve probably heard a lot about health savings accounts (HSAs) recently. They have been all over the news because the industry saw a 29 percent increase in the number of accounts in 2014. In fact, UMB Healthcare Services recently reached 600,000 accounts and $1 billion in assets and deposits for HSAs.

So what is an HSA?

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To be eligible for an HSA, you must be enrolled in a qualified High Deductible Health Plan.  An HSA is a savings and investment tool for current or future qualified medical expenses. HSA deposits and earnings grow tax-free,1 and your withdrawals are tax-free as long as you spend the money to pay for eligible medical expenses. Deposits into your account up to the annual contribution limits and any interest on those deposits are not taxed. At the end of the year, the money you have saved rolls over and continues to do so throughout the duration of your HSA’s life. Many companies will also contribute to or match your HSA funds to a certain amount; free money for your medical expenses. You can find out even more about HSAs here.

Another type of account to consider, if it is offered by your employer, is a flexible spending account (FSA).

A FSA is also a tax-advantaged savings account. You can set aside funds each year to cover qualified medical costs throughout that year. Some companies will even contribute to your FSA. The big difference between an HSA and an FSA is that the funds you put into an FSA have to be used by a certain date or the money is forfeited. Learn more about FSAs here and take a look at our chart that compares three types of consumer directed health care.

Comparison of Consumer Directed Healthcare

 

1All mention of taxes is made in reference to federal tax law. States can choose to follow the federal tax-treatment guidelines for HSAs or establish their own; some states tax HSA contributions. Please check with your state’s tax laws to determine the tax treatment of HSA contributions, or consult your tax adviser. Neither UMB Bank n.a., its parent, subsidiaries nor affiliates are engaged in rendering tax advice.

 

When you click links marked with the “‡” symbol, you will leave UMB’s website and go to websites that are not controlled by or affiliated with UMB. We have provided these links for your convenience. However, we do not endorse or guarantee any products or services you may view on other sites. Other websites may not follow the same privacy policies and security procedures that UMB does, so please review their policies and procedures carefully.


UMB Financial Corporation (Nasdaq: UMBF) is a diversified financial holding company headquartered in Kansas City, Mo., offering complete banking services, payment solutions, asset servicing and institutional investment management to customers. UMB operates banking and wealth management centers throughout Missouri, Illinois, Colorado, Kansas, Oklahoma, Nebraska, Arizona and Texas, as well as two national specialty-lending businesses. Subsidiaries of the holding company include companies that offer services to mutual funds and alternative-investment entities and registered investment advisors that offer equity and fixed income strategies to institutions and individual investors.



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Credit Card Debt vs. Emergency Funds

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You probably already realize the importance of keeping an emergency fund for unforeseen events such as auto repairs or health issues. However, actually saving for the unexpected can be a challenge. By not planning, you can put yourself at risk for financial disaster.

A recent poll from Bankrate revealed 24 percent of Americans have more credit card debt than they have in their emergency savings. Most people, 58 percent, who don’t struggle with credit card debt still fall short when it comes to having a strong emergency fund.

emergency savings vs. credit card debt

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Greg McBride, Chief Financial Analyst at Bankrate, can’t stress enough the poor situation consumers are putting themselves into. “These numbers mean that three out of every eight Americans are teetering on the edge of financial disaster,” says McBride.

How to manage credit card debt

While there isn’t one definitive way to erase credit card debt in a hurry, below are a few helpful tips to expedite the process.

  1. Tackle high interest debt first
    It may be easier for you to stick with a debt payoff goal if you attack the card with the lowest balance. However, most financial experts agree that the best practice is to pay down the balance on the highest interest card first.
  2. Double or triple payments
    Consider doubling or tripling your monthly payments, or apply tax refunds towards outstanding balances. The faster you can tackle your highest interest card, the sooner you will reach a debt-free lifestyle.
  3. Stick with your plan
    When faced with high debt, it is critical to track and budget expenses to monitor progress and keep spending habits under control. Once the highest-interest card reaches a balance of zero, it’s time to move on to the next highest interest card.
  4. Build an emergency savings
    Building an emergency fund is just as important as getting debt under control. Tuck away money each month and set aside for emergencies only. Do this even if it means paying less on your debt payments. Most experts agree that a healthy emergency fund equals at least six months of living expenses.

Getting credit card debt under control requires excellent planning, dedication and patience. Once goals are met, it is important to keep moving forward with healthy spending and savings habits.  Being financially prepared for life’s unexpected events is smart. Having peace of mind is priceless.

 

When you click links marked with the “‡” symbol, you will leave UMB’s website and go to websites that are not controlled by or affiliated with UMB. We have provided these links for your convenience. However, we do not endorse or guarantee any products or services you may view on other sites. Other websites may not follow the same privacy policies and security procedures that UMB does, so please review their policies and procedures carefully.




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Financial Word of the Week: Tax Exemptions

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Financial Word of the Week

To wrap up this tax month, let’s talk about exemptions—special deductions that you can use to lower your taxable income.

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Exemptions are a set amount of income that is not subject to income tax. This amount could change each year and could be reduced if your adjusted gross income is above a certain amount. For 2014, you may deduct up to $3,950 for each exemption you claim. You may claim exemptions for yourself, your spouse and any dependents.

Phaseout of Exemptions (2014)

Filing Status                                       Adjusted Gross Income Level That Reduces Exemption Amount

Married Filing Separately                                       $152,525

Single                                                                                 $254,200

Head of Household                                                    $279,650

Married Filing Jointly                                               $305,050

Qualifying Widow(er)                                               $305,050

For example, if you are married and have two qualifying children, you may be able to claim four exemptions. For 2014, this would equate to an exemption amount of up to $15,800 ($3,950 x 4).

If you can be claimed as a dependent by another taxpayer, then you are not allowed an exemption for yourself on your own tax return, even if the other taxpayer does not actually claim you as a dependent.

A dependent can be either a qualifying child or other qualifying relative, but your spouse can never be considered a dependent. Special rules are used to determine whether someone can be considered a dependent.

For more information on exemptions, refer to IRS Publication 501.

 

*This post is not meant to replace the advice of a tax professional.

When you click links marked with the “‡” symbol, you will leave UMB’s website and go to websites that are not controlled by or affiliated with UMB. We have provided these links for your convenience. However, we do not endorse or guarantee any products or services you may view on other sites. Other websites may not follow the same privacy policies and security procedures that UMB does, so please review their policies and procedures carefully.


UMB Financial Corporation (Nasdaq: UMBF) is a diversified financial holding company headquartered in Kansas City, Mo., offering complete banking services, payment solutions, asset servicing and institutional investment management to customers. UMB operates banking and wealth management centers throughout Missouri, Illinois, Colorado, Kansas, Oklahoma, Nebraska, Arizona and Texas, as well as two national specialty-lending businesses. Subsidiaries of the holding company include companies that offer services to mutual funds and alternative-investment entities and registered investment advisors that offer equity and fixed income strategies to institutions and individual investors.



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Teach Children to Save

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Do your kids know that money doesn’t grow on trees? Here are some helpful tips for each age group.
Teach Kids to Save

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You don’t have to wait until your kids are teenagers. You can start talking to them about the basics of money as early as preschool. Here are some tips about how to talk to your kids about money at any age:

  • From ages three to five you can teach kids that money can be exchanged for things. Explain to them the difference between pennies, nickels, dimes and quarters.
  • From ages five to nine you can start giving them an allowance. This is also a good time to explain bank accounts and what it means when a bank account earns interest.
  • From ages nine to 13 you can help them open a savings account. Encourage them to save their allowance towards a goal (a new toy or a DVD). You might even consider setting up a matching savings plan like most companies do with a 401(k). This is also a good time to start talking to them about the idea of keeping a minimum balance based on the savings account requirement. You can also introduce the concept of keeping savings in case of emergency. Even though they won’t need to pay for an emergency at such a young age, you can explain the importance of keeping a nest egg.
  • From ages 13 to 15 you can expand your children’s allowance to include more expensive items like clothes or gifts for friends. This is also a good time to introduce entrepreneurship. Encourage your kids to earn their own money with jobs for neighbors and friends.  Arrange for them to have an ATM card so they can withdraw money from their savings account.
  • From ages 15 to 18 and up you can help your children open a checking account with a debit card. Teach them how to manage their account online or with mobile banking. You can even go old school and show them how to use a check register. This is also a good time to talk fiscal responsibility about when they go off to college. Be very clear about what expenses you will pay for which ones they will cover.

Explaining money management to your kids can start out with something as simple as giving them an allowance. If you talk to them regularly, teach by your own fiscally responsible example and give them the right tools, you will do more than teach them about money basics. You will instill in them a respect for earning and saving money that will hopefully set them on a path to being financially independent and responsible in adulthood.




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UMB Insights: Payments Landscape

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UMB Industry Insights

Each year, there are 200 billion transactions that equal nearly 100 trillion dollars. Learn more about the challenges and opportunities facing the payment landscape today, such as:

  • Innovation
  • Behavior
  • Globalization

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Mr. Thelen is executive vice president of Treasury Management for UMB. He is responsible for treasury management sales and products, international services, capital markets and commercial healthcare banking, which include overseeing client management and service, product innovation and delivery, risk and compliance. He has more than 20 years of experience in the financial services industry.



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Financial Word of the Week: Tax Bracket

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FWOTW

Earlier this month, we discussed tax deductions and charitable deductions. This week, we want to talk about tax brackets.

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The United States has a progressive tax system, which means your marginal tax rate increases as your taxable income increases. Tax brackets indicate the marginal tax rate that applies to you based on whether your taxable income falls within a certain range or “bracket.” There are seven tax brackets in the United States, with marginal tax rates ranging from 10 percent to 39.6 percent.

A marginal tax rate is the tax rate you pay on each additional dollar of income. In other words, the first dollar of taxable income is taxed at the lowest rate. As your taxable income increases into the next bracket, only those dollars within that bracket are taxed at the new marginal tax rate.  The actual percent of your taxable income that you pay to the IRS is called your Effective Tax Rate.

Remember that your taxable income is the income left over after subtracting all allowable deductions and exemptions. We’ll discuss exemptions in our next tax-related financial word of the week.

To see which tax bracket might be applicable to you, please refer to the IRS website or see the below example.

Income-Tax-Rates-table

*This post is not meant to replace the advice of a tax professional.

When you click links marked with the “‡” symbol, you will leave UMB’s website and go to websites that are not controlled by or affiliated with UMB. We have provided these links for your convenience. However, we do not endorse or guarantee any products or services you may view on other sites. Other websites may not follow the same privacy policies and security procedures that UMB does, so please review their policies and procedures carefully.


UMB Financial Corporation (Nasdaq: UMBF) is a diversified financial holding company headquartered in Kansas City, Mo., offering complete banking services, payment solutions, asset servicing and institutional investment management to customers. UMB operates banking and wealth management centers throughout Missouri, Illinois, Colorado, Kansas, Oklahoma, Nebraska, Arizona and Texas, as well as two national specialty-lending businesses. Subsidiaries of the holding company include companies that offer services to mutual funds and alternative-investment entities and registered investment advisors that offer equity and fixed income strategies to institutions and individual investors.



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Tax Facts {infographic}

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How much do you know about taxes?  If you’re like a lot of people, you just want to know how much you owe the IRS or how much the IRS owes you. But if you dig deeper, you will be amazed at how our income tax system has evolved and some of the interesting factoids that would astound even the most seasoned tax professional. To get ready for Tax Day tomorrow, arm yourself with some cocktail party chatter by taking a look at the infographic below.
Tax Day infographic

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Mr. Chen is a Vice President and Portfolio Manager for UMB Private Wealth Management. He is responsible for all aspects of portfolio construction, including asset allocation, security selection and mutual fund analysis for high-net-worth clients. He joined UMB in 2013 and has 10 years of experience in the financial services industry. Mr. Chen earned a Bachelor of Science in Business with an emphasis in Financial Management from Kansas State University and Master of Science in Business with a Finance Concentration from the University of Kansas. He serves on the board of directors for the Financial Planning Association of Greater Kansas City and the Kansas City CFA Society. He is a Certified Financial Planner® and is a CFA charterholder.



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