Making Money Playing The Fed At Its' Own Game

Includes: BKCC, KKR, WFC
by: Regarded Solutions

Not 2 minutes can go by in the world of money and markets, without hearing something about the Federal Reserve. Most of the time it revolves around what they will, or won't do, and for how long. It appears that the stock market hangs on every word and every nuance that any of the Fed Governors utter, even in passing.

We CAN make money folks, by using the Fed policies to our advantage.

The fact of the matter is that the Federal Reserve will continue the current policies that they have in place for an indefinite period of time. The latest FOMC press release reflects an ever accommodating monetary policy, and in my view the Fed could become even more accommodating if the current employment and inflation trends stay at current levels.

The latest FOMC press release confirms what we already know:

The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes

As far as I am concerned, this basically lays it out for everyone to know that the Fed will not do anything other than what it already is doing, if not even more.

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored

Wow, the Fed is also saying that even if they decide to end asset purchases, they will STILL remain accommodative. From my vantage point, it looks like low interest rates are going to be with us for a very long time. As a matter of fact, many folks think deflation is a bigger issue which could mean even more money being pumped into the system.

......the Fed's policymakers want prices to go up because they believe that a little bit of inflation is good for growth. The Fed wants interest rates to be below the rate of inflation to give homeowners and businesses a strong incentive to borrow and spend, generating jobs. The Fed can't do that if there's no inflation because interest rates can't be lower than zero.

Second, inflation really is below 2 percent. Over the past year through March, consumer prices rose just 1.5 percent. Excluding food and energy, which jump around a lot, consumer prices rose 1.9 percent. That's according to the Consumer Price Index of the U.S. Labor Department's Bureau of Labor Statistics.

It does not really matter what we mere mortals think about rising food and gas prices, as long as the Fed sees no inflation, the printing presses will continue to roll.

The question that investors should be asking themselves, is; how can we profit from the policies right now. The bottom line for each of us is to take advantage of this environment and make money, period.

What Should Investors Consider?

I am going to keep this brief and to the point:

Any company that borrows money to make money will make investors money.

Now, that might look like a broad stroke for just about any company, but in particular, here are the stocks I feel will benefit most from all of this:

  • Wells Fargo (NYSE:WFC)

Wells Fargo can borrow cheap money and lend at rates that can increase their profits. From auto loans to mortgages, when a bank like WFC begins to offer deals on loans, it will make money hand over fist. By lending more, WFC almost guarantees that both their revenues and profits will rise in the future. In turn, the company will have more cash, and that should mean higher dividends paid to shareholders. (The company has already increased dividends by 36% in 2013 so far)

WFC is already the leading mortgage lending bank, and the company has added more employees to increase this business, as the housing market continues healing and growing.

As I detailed in this article, WFC is showing other big banks "the way":

Wells Fargo seized the moment, and significantly increased the dividends it pays, and have put the final stamp of approval on the deal as noted in this press release.

Wells Fargo & Company today announced a quarterly common stock dividend of $.30 per share, an increase of five cents, or 20 percent, per share from the prior quarter. The dividend is payable June 1, 2013, to stockholders of record on May 10, 2013, as approved today by the Wells Fargo (WFC) board of directors.........."The dividend increase approved by our board today is up 36 percent from a year ago and reflects the confidence we have in our company's performance, Chairman and CEO John Stumpf said. We remain committed to returning more capital to our shareholders."

It is also no secret that there are many more reasons to buy a home these days, which of course translates into more mortgage lending for WFC, which leads all banks in mortgage lending already.

  • Blackrock Kelso (NASDAQ:BKCC)

BKCC is a BDC, or "business development company". The double edge sword of low interest rates not only help banks make money by lending more to qualified borrowers, also means that the banks can be more discerning when it comes to the requirements to qualify. Many companies (especially start-ups) might need to look elsewhere for funding. Enter the business development companies.

BDC's will lend to new companies and companies in need that might not be able to qualify for the new stricter lending guidelines from the banks. The catch is that the BDC will lend at higher rates (although they are still able to borrow cheaply themselves) to take on a higher level of risk. That means a company like BKCC can increase revenues and profits just by lending to companies that banks will not. Greater risk equals greater rewards. In addition to making money on these loans, a BDC will take an equity stake in a business, especially where they see strong potential, and add even more profit potential. As a result, BKCC works on much higher operating margins (currently over 65%). In a healing economy, BKCC can rake in tremendous profits and is mandated by the IRS to pay shareholders at least 90% of its net income.

More revenues, more profits, more dividends for shareholders.

BKCC announced 1st quarter earnings yesterday morning, and it looks just ok. I believe going forward business will be stronger. Some earnings commentary:

BlackRock Kelso Capital Corporation (NASDAQ:) (BlackRock Kelso Capital or the Company, we, us or our) announced today that its Board of Directors has declared a quarterly dividend of $0.26 per share payable on July 2, 2013 to stockholders of record as of June 18, 2013.

We are pleased with our first quarter performance and as we look further into 2013, we are optimistic about our current position. We remain focused on continued prudent growth while adhering to our conservative investment philosophy focusing on preservation of capital.

The conference call was held after the market closed yesterday, and while the quarter faced prepayment issues, shareholder value in terms of dividends, and prudent portfolio management of capital preservation, remains the main focus of the company as noted by James Maher, CEO:

........ our watch word for the current investment environment is patience. We're focused on growing our portfolio prudently with a continued focus on capital preservation. We're also focused on our continued dividend coverage and remain comfortable about the level of our dividend as we look into the remainder of the year.

All reports including the conference call can be reviewed on the company website of course;

  • KKR Holdings, LLC. (KFN)

Much like a BDC, KFN will borrow low and lend high. The company is a limited partnership or LP, which will also invest in companies that find it difficult to qualify for a loan from a bank. KFN will also take an equity position in some of the companies if they see growth potential. This company has also just released their latest earning sreport and discussed the results on its conference call.

Mike McFerran - CFO and COO, stated:

This morning we announced first quarter net income available to common shareholders of $92 million or $0.46 per diluted common share. This compares to $77 million of net income or $0.40 per diluted common share for the fourth quarter of 2012. The largest driver of this increase was realized and unrealized gains on investments which have benefited and continued strong performance in both the equity and debt benefits.

First quarter net income consisted of $140 million of total revenues, $81 million of total investment cost, $74 million of other income and $35 million of other expenses. Our total revenues increased 5% from the fourth quarter the biggest drivers here were oil and gas and other revenue which increased $3.5 million $2.7 million respectively from last quarter. Other revenues primarily consisted of dividends from a combination of special situations real estate and opportunistic energy investments.

If I was a professional analyst covering this company, I would be upping my rating to a buy. From this statement alone, it looks like KFN is hitting on all cylinders.

Again, KFN borrows low, lends (and invests) high, and that should return strong shareholder value in both capital appreciation and dividend income.

Is That All There Is?

I have said it before and I will say it again; as long as the Fed is giving out cheap money to the financials, the financial sector will outperform other sectors, and drive other parts of the economy at the same time.

  • The housing market will continue to recover and grow because interest rates for mortgages are at an all time low. More buyers will mean higher prices. It is called the law of supply and demand. If the demand is there, the supply will be offered at prices that the market will bare. So far, increasing housing prices are at their strongest pace since 2006.
  • If construction continues to pick up, then more people will be employed and the peripheral companies like Home Depot (NYSE:HD), Lowe's (NYSE:LOW) and Mohawk Industries (NYSE:MHK) will benefit from increased sales and profits, and that will enable these types of companies to hire more as well. Not only do these companies help "feather the nest", but they are also heavily involved in new construction.
  • As more peripheral companies profit, then income and spending will increase, and we are already seeing that in the auto industry. The latest results of the "big three" are continuing to show improved sales and profits. That does not happen in a vacuum. It all can be traced right back to the core issue, cheap money from the Fed policies.

Automakers posted their strongest April sales since 2007 as many reported double-digit gains with trucks and SUVs leading the surge....."A lot of this comes from housing, an increase in construction, and the economy recovering in general," Caldwell said. "It's also not just construction but people investing in businesses."......Improvements in fuel economy and low financing rates also pushed more buyers into sport utility vehicles and crossovers, according to Jesse Toprak, an analyst for

The list will and can go on and on, and perhaps I am painting too rosy of a picture. Well, I am an unabashed bull on the stock market, as well as the US economy. As long as there is cheap money, easy to get, then I believe our economy will grow. I also realize that the largest issue from these very same policies are the puny interest rates on savings. That IS an issue.

I believe that it is time to quit complaining about the Fed policies and to take the money from under the mattress and put it to work in the ONLY game in town; The stock market.

Take what the market is giving, and you WILL make money!

Prudent investors who buy shares in great companies that will pay us to hold and buy shares, is perhaps the only way we can obtain a better standard of living, aside from actually investing in ourselves in our own business.

The BIG Risk

It is not often that investors can point to the same source of rewards, as the biggest risk. If the Fed stops their policies too quickly, or all at once, or abruptly decides to end their zero interest policy, then all bets are off and not only the stocks I noted here are in trouble, but the entire global economy will be at risk.

It could happen, but I doubt it.

It is more essential now than ever before, that investors keep up with not only corporate events, but the policy makers in Washington D.C. We must be prepared to act quickly, but in the meantime, we will play this game to win.

Disclosure: I am long BKCC, KFN, WFC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.