3 Surprising Lovers of Low Interest Rates
Income investors hate low interest rates, but surprisingly, Bank of America , American Capital Agency , and Uncle Sam have loved them.
Where we've been...
Since the collapse of the housing market near the end of 2007, interest rates have been at unprecedented lows relative to their historical averages. The Federal Funds rate, which is the interest rate set by the Federal Reserve against which almost all other rates are benchmarked, currently stands right at 0.09%. This is the 267th week in a row (beginning in October 2008) it has been below 1%, and the 260th week in a row it has been below 0.5%:
To put that into perspective, from January 1955 to September 2008, only 32 of the 2,806 weeks saw a Federal Funds Rate below 1%, and only twice was it below 0.5%. Thanks to both conventional and unconventional monetary policy from the Federal Reserve and other central banks, the United States and essentially all other advanced economies have seen interest rates at historic lows.
The mortgage REITs
The shares of mortgage REITs have taken a hit lately, especially American Capital Agency and Annaly Capital Management , but that was because they benefited dramatically from the low interest rate environment. These investments make their money by borrowing short-term debt and using it to buy longer-term (and higher-yielding) securities, and as a result of the low borrowing rates, their stocks had incredible runs from 2009 to the beginning of this year:
However, as you can see, as rates have risen in recent months, they have been crushed, and the performance of their stocks has suffered as long-term yield caught up to the companies and crimped margins. These mortgage REITs' managers and investors hope rates return to a steep curve.
The big banks
As seen with the mortgage REITs, low interest rates have advantages and disadvantages, and the same goes for the biggest banks. Banks like Wells Fargo , Bank of America, and JPMorgan Chase all make a significant amount of their income from what is known as net interest income, which is the difference between what a bank earns from loans versus what it pays out on deposits and other liabilities.
Interestingly, although net interest margin (the rate of net interest income) has been on the decline since it peaked in 2010 following the financial crisis (since they were collecting money on long-term loans with higher rates versus paying out low rates on short-term liabilities), on a relative basis, while things are certainly below historical norms, it is not nearly as dramatic as one would expect:
Banks are hurt by this lack of income, but recently, the McKinsey Global Institute, the research arm of the consulting firm, published a report that examined the impact of the low interest rates and found that banks in the U.S. actually had a total benefit of $150 billion between 2007 and 2012 as a result of low interest rates. In fact, the same study found that the impact of low interest rates in the eurozone actually hurt banks there by reducing net interest income by $230 billion, which led to "divergence in the competitive positions of US and European banks."
The biggest benefactor of the low interest rate environment was not the banks, as non-financial corporations were able to benefit from the cost of their debt falling, resulting in a benefit of $310 billion in the U.S. alone. Yet that figure of $310 billion couldn't surpass the $900 billion difference in net interest income posted by the United States government, the biggest winner from the low interest rates.
The federal government
Consider the rate of 1-year U.S. Treasury bonds over the past 50 years as shown in the chart below:
In the 2,445 weeks before November 21, 2008, the yield on a bond was below 1% only twice, during a two-week stretch in June of 2003. Yet since then, rates have been below 1% for 262 consecutive weeks, and considering the yield currently sits at 0.13%, that streak is likely to continue into the foreseeable future. The previously mentioned study found that the effective rate the U.S. paid out on its total debt fell from an average of 4.8% in 2007 to 2.4% in 2012.
Interest rates paid on debt are the result of supply and demand, and as a result of the U.S. continuing to be one of the safest sources for investors seeking to keep their money secure, even despite the turmoil in Washington, countless dollars have flooded into the U.S. that helped finance the debt at ultra-low rates. In addition, although the U.S. government has been the biggest beneficiary in terms of raw dollars, this is also in large part because of the massive debt it holds on its balance sheet.
The financial crisis had a disastrous impact on the global financial landscape, and only now are we beginning to truly recover, but one unintended benefit of low interest rates was the impact to the federal government's bottom line.
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The article 3 Surprising Lovers of Low Interest Rates originally appeared on Fool.com.Fool contributor Patrick Morris owns shares of Bank of America. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Bank of America, JPMorgan Chase, and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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