Taking Advantage of Lower Interest Rates

By Wayne F. Currie

The Federal Reserve has stated it is finished reducing rates. At 1.25 percent, there isn't anywhere much for them to go! This has resulted in already low savings account and money market rates declining further. The question is: what does this mean to mason contractors?

Let's take a look at what a mason contractor can do to take advantage of the interest rates and cost of money in today's market. First, understand that any cash on hand is going to reap very low interest when deposited in a bank. On the other hand, if you are thinking of borrowing any money, particularly for real estate or equipment purchases, you are going to find especially low rates � the timing is excellent.

In many markets, real estate has slowed down and prices have stabilized or dropped. In addition, excess inventory in vehicles and some heavy equipment has pushed prices down. Many of you are seeing "zero down" programs with zero interest, and in some cases zero payments, for a certain period of time.

Key to the decision to do something now may also be a slight change to the tax laws allowing you more depreciation this year. As you may know, depreciation is a non-cash expense that goes toward generating cash for equity payments on loans or for income yielding investments.

What if you have some cash on hand? What should you do? Well first, if you have a significant amount of taxable income take a look at the Nuveen Dividend Advantage Municipal Bond Funds. This company is an expert at buying tax-free municipal bonds in different jurisdictions so that if you have a state of residence where one of their many choices is available, such as Georgia, you get the interest tax-free.

The objective of these closed-end municipal bond funds is to have steady asset values and high tax-free income. The shares are bought and sold on the market similar to ordinary company shares, but these are fixed portfolios of targeted municipal bonds. The cash flows are enhanced by borrowing in the fund, which is done by selling notes to corporations who want tax-free income of two to three percent, short term. The fund invests the proceeds in longer-term municipal issues and gets 4.5 to five percent yields, enhancing the return to shareholders.

Therefore the average fund is returning a six to seven percent, tax-free cash yield to typical buyers. The funds generally pay monthly income to shareholders, enhancing compounding opportunities, and you can sell out and have your money back in as little as three days, at any time. The typical fluctuation in share value is very small, the low for a year typically around $13.50 and the high around $15.50. Most of the funds are issued at $15.

Here's an idea for those of you who want to make some free interest on $1,000,000. If you buy $1,000,000 of one of the Nuveen funds at an appropriate time and price (for instance, January at $14) you might see $66,000 in tax-free income. If we assume there is no appreciation or loss of value, you might borrow $500,000 against these at your broker dealer at a cost of about 4 percent, tax deductible for tax purposes. The net result is a $20,000 interest expense, which in an average state might cost $15,000 after taxes, with the balance of the interest reducing your tax bill. The net income of the Nuveen fund will be $51,000 on equity you invested of $500,000. Your after-tax rate of return should be in the 10 percent range.

It's also important to note that Standard and Poors rate the bonds in these funds AA � and many of them are insured by Amback to make them AAA. This is generally a higher rating than bonds issued by major money center banks and much more secure than a typical CD or bond from a regular bank.

If you have a need to borrow for a home, US Mortgage recently had an offer of up to $1,000,000 for 3.45 percent, with a payment on $1,000,000 of $2800 per month on an adjustable rate mortgage with a one-year term. This could be a good strategy while waiting for 30-year rates to drop down further.

Mitsubishi Motors offered a series of attractive mid-priced vehicles with no down payment, no payments for 10 months and 5.7 percent when payments do start. There are also very low home equity rates out there, less than four percent, interest only. If you were considering refinancing, now could be the time, since many of these loans are pegged to LIBOR, the London Inter-Bank Offer Rate, which was 1.55 percent for one year on the day this was written. This is down from 2.15 percent a year ago.

While commercial loans have not adjusted down as fast, the Wall Street Journal Bank Prime Lending Rate was 4.25 percent on November 15, 2002. Thus, Prime plus one percent is 5.25 percent, making many projects you might want to undertake a lot cheaper to do. This in turn may make the rate of return on investment particularly good for acquiring your competitor or expanding to the next state though acquisition.

While regional banks are not aggressively making loans, even though a low Federal Funds rate helps them with liquidity, good projects will get funding. As you probably know, any kind of borrowing needs to be done carefully and with plenty of planning before you commit. However, with the lowest overall rates in 40 years, many of your fellow business owners are looking at ways to undertake their favorite expansion program.

Where recessionary conditions seem to be prevailing in many markets, Warren Buffett of Berkshire Hathaway, known as the oracle of Omaha, believes strong business owners seize market share when competitors are experiencing dropping sales. Low interest rates are an invitation to profitable enterprise owners to gain and grow at the expense of faltering local competitors, or enter new geographical markets. Therefore, those of you who have had good revenue in the past two or three years could be poised to make profitable acquisitions, financed by the SBA or your regional bank. Normally the elimination of management salaries, personal deductions, and overheads from the prior owners will be significant to the amortization of debt and be easily carried by acquiring the new customer base.

In summary, lower interest rates are beginning to present opportunities that are significant. Which ones work for you is a personal analysis you will need to undertake. However, you may get help from your CPA or business advisors � but doing nothing with this time of opportunity is probably the worst decision you can make.