[A-List] End of Low Interest Rates
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Sat Jun 23 19:57:47 MDT 2007
Fallout from end of low-interest rates likely to be widespread in U.S.
By Gretchen Morgenson and Vikas Bajaj
Friday, June 15, 2007
NEW YORK: The unusually low interest rates of the last three years
have been an enormous boon to almost every corner of the U.S. economy.
They have provided consumers with dirt-cheap mortgages that fed the
real estate boom. They have supplied easy credit to companies and
investment firms, propelling stocks and corporate profits to record
highs and fueling a buyout binge.
Now that party may be coming to an end.
Yields on the 10-year Treasury note - a benchmark that influences many
long-term interest rates, including home mortgages - jumped sharply on
Tuesday and are up significantly in the last month. The fallout is
likely to be widespread, and felt most immediately by homeowners and
people looking to buy homes.
Economists said homeowners trying to refinance their adjustable-rate
mortgages before they reset to higher levels are already feeling
pinched. The national average for the 30-year fixed-rate mortgage
jumped to 6.74 percent Thursday. At the beginning of the year, the
average was 6.18 percent, according to Freddie Mac, a big buyer of
Last year, adjustable-rate loans accounted for 25 percent of mortgage
applications, up from 11 percent in 1998, Freddie Mac said.
Demand for adjustable-rate loans peaked in 2004 at 33 percent; many of
those are at or near the reset point.
"It's going to be tough," said Adam Stein, president of the Washington
Association of Mortgage Brokers in Seattle. "I talk to people every
day looking to get the fixed rate. You give them the current rate and
they say, 'That doesn't do anything for me."'
Homeowners are not the only ones who will have to swallow higher
costs. Corporations, accustomed to financing operations with cheap
debt, will see their expenses rise, cutting into profits. In addition,
rate increases will crimp the private equity buyout boom, which has
been fed in large part by the heavy issuance of corporate debt at low
"There has been a half a percentage point rise in rates while
inflation has been flat, so the real cost of capital has gone up for
consumers and for Corporate America," said Mickey Levy, chief
economist at Bank of America. He said he expected the increase to put
pressure on stocks and dampen already-weak demand for housing.
The recent rate move came as something of a surprise to Wall Street.
It is the result, traders say, of heavy selling by foreign investors,
who may be growing concerned about inflation, and holders of mortgage
securities hoping to reduce the risks associated with higher rates.
Some bond strategists said the recent rate spike is only the
beginning. The sharp increase, they said, is just starting to bring
interest rates back to their normal or long-term trend levels.
"Bond yields have been so low for so long," said Richard Suttmeier,
chief market strategist at RightSide Advisors. "But yields in the
10-year have moved up almost 100 basis points since the end of
February. That, to me, is a big shock and enough for people to take
Particularly hard hit will be consumers with weak credit - known as
subprime borrowers - who are faced with mortgage rates that will soon
reset to higher, in some cases double-digit, levels. Some $100 billion
in subprime loans are scheduled to reset between now and October.
For struggling homeowners, the rise in rates could not come at a worse
time. "In prior foreclosure waves, we had a drop in interest rates
that allowed workouts to be done at lower interest rate levels," said
Louis Barnes, a partner at Boulder West, a mortgage banking firm in
Lafayette, Colorado. "Today rates are substantially higher than when a
lot of these loans were created."
Consumers will not be the only ones encountering higher borrowing
costs. Corporations will also have to absorb greater expenses, putting
pressure on profits and stock prices.
"The trajectory of corporate profits has flattened out after growing
in double digits for several years," Levy said. "The stock market
could handle that when rates were low, but a 50-basis-point rise in
real bond yields should have dampening impact on stock valuations."
The private equity buyout boom that has contributed to the bull market
in stocks will also face headwinds. While prevailing rates remained
below 5 percent, deals financed by corporate debt issuance worked
well. As rates move up, the economics of selling big bond issues to
pay for the deals becomes more difficult.
Consider Alltel, the nation's fifth-largest cellphone company, which
is being taken private in a $27.5 billion deal by Texas Pacific Group
and Goldman Sachs.
This week, Alltel said it would take on about $21.7 billion in debt to
pay for the transaction. About $14 billion of that debt will be
secured loans, but Alltel must sell $7.7 billion in bonds to get the
Assuming the bonds carry an 8 percent to 9 percent interest rate, the
range for comparable telecommunication debt issued recently, Alltel
will probably spend almost all the cash that it earns to service the
debt, said Ping Zhao, a senior analyst at CreditSights.
Zhao further assumes the company's service revenue will grow 7.3
percent this year.
Alltel could prove to be a critical test of investor sentiment, said
Kingman Penniman, chief executive of KDP, a bond research firm.
"The first cracks will appear when you can't do the $14 billion or the
$8 billion deals," he said.
For now, investors still appear to be receptive, said Andrew Feltus, a
high-yield fund manager at Pioneer Investments. "The market seems to
be saying, 'I have got the money; I have got to put it to work.' "
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