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February 27, 2025 | Georgina Walleshauser, Vice President
The Impact of Interest Rate Changes on Bond Reinvestment Decisions
It is important to consider the current interest rate environment when deciding how to reinvest tax-exempt bond proceeds. In particular, the yield curve can offer signals for how to best optimize a reinvestment structure. It is also important to consider the expectation of interest rate movements in the near future. While future interest rates cannot be predicted with certainty, reinvestment rates are shorter term and tend to closely follow the federal funds rate, for which the FOMC offers certain market signals. Below we summarize key considerations for various market conditions.
Positive Sloping Yield Curve
In a positive sloping yield curve environment, borrowers and issuers can take advantage of locking in a higher interest rate with a fixed-rate investment of their bond proceeds. For funds that are borrowed and not needed immediately, they can be reinvested at a longer, higher interest rate until they are needed, rather than leaving them in a variable rate product that is based on shorter term, lower interest rates.
Inverted Yield Curve
In an inverted yield curve environment, borrowers and issuers have a unique opportunity to potentially earn a higher rate on their reinvestment products compared to their longer-term borrowing rate. It is important to consider the expenditure schedule and monitor positive arbitrage earnings in this type of market. Certain exceptions can be met which allow the tax-exempt borrower to keep their positive arbitrage earnings. Otherwise, a rebate payment will be due five years following the bond closing.
Increasing Interest Rate Environment
In an increasing interest rate environment, some borrowers and issuers elect to keep their bond proceeds in a liquid, variable rate product. This approach allows for the funds to remain essentially fully liquid. Alternatively, for borrowers and issuers who do not need their funds immediately, they may choose to reinvest the proceeds in a “rolling” structure – where the proceeds are invested for a shorter period of time (1-6 months) and reinvested at each maturity date. This can allow the borrower or issuer to take advantage of the potential for increased rates in the future.
Decreasing Interest Rate Environment
In a decreasing interest rate environment fixed rate products are the most beneficial to borrowers and issuers as it allows them to lock in a fixed rate for their proceeds. It is important to carefully structure the reinvestment product in order to maintain flexibility. Certain fixed-rate products allow for draw flexibility, such as a guaranteed investment contract (“GIC”) or repurchase agreement. A laddered portfolio of securities can also be structured to maintain flexibility by leaving a portion invested in a variable rate liquid investment product.
Meet the Author:
Georgina Walleshauser, Vice President | 952-746-6036
In her role of Vice President, Georgina Walleshauser manages a number of the firm’s clients, providing them with advice on and ensuring a smooth closing for all types of debt and derivative product transactions, capital planning solutions, and detailed credit assessments. Ms. Walleshauser serves as an advisor to public and private higher education, non-profit and governmental institutions. She specializes in analyzing and assessing reinvestment strategies for clients, leading most of Blue Rose’s reinvestment transactions. Ms. Walleshauser has vast expertise in providing modeling, analytics, market data, and research in support of the delivery of capital planning, debt and derivatives advisory, and reinvestment services to our clients. She joined Blue Rose in 2017 as a Junior Quantitative Analyst.
About Blue Rose Capital Advisors:
Blue Rose Capital Advisors is an independent financial advisory firm that serves the higher education, healthcare, non-profit, government, and corporate sectors. Blue Rose provides debt, derivatives, reinvestment, strategic and financial consulting services, and other specialized services to help clients achieve their goals. Blue Rose is registered as a Municipal Advisor with the Securities and Exchange Commission (SEC) and Municipal Securities Rulemaking Board (MSRB).
Blue Rose brings expert guidance and transparency to the often complex and opaque sectors of the capital markets. We embrace a client-first approach and work tirelessly to strengthen their debt transactions, governance, and balance sheets. With our wealth of real-time data, sophisticated modeling capability, and deep industry relationships, we can deliver solutions to almost any financing challenge.
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