Libor Jump Means More Pain for Financials

Between April 14th and April 18th, the Libor rate jumped sharply to 2.9%, up from 2.7%. This increase, which was unexpected, will “add billions of dollars to the interest bills of home-owners, companies and other borrowers around the world, ” according to the Wall Street Journal.

What does this mean? Well, it means that any debt pegged to the Libor – about $9 trillion worldwide – would see an increase in interest payments. This comes at a very precarious time when homeowners are struggling to pay their mortgages, and many ARMs are resetting using Libor as a floor. Not only will this increase hurt residential real estate, it will also hurt – and quite severely – commercial real estate. Commercial real estate is typically highly leveraged using floating-rate Libor debt.

It is my belief that we will see dramatic losses, like the ones we’ve been seeing with residential real estate, in commercial real estate. When that happens, banks that are already reeling to cope with the residential mess will be in for another wave of losses and write-downs.

Here at Freund Investing, we have recommended buying shares of SKF, the UltraShort Financials ETF, which goes up 2% for every 1% the Dow Jones US Financials index goes down using swaps. It is currently priced relatively low, thanks to the rallies seen in the past week. SKF contains short positions in the most vulnerable banks and investment banks. The top 10 holdings of SKF, as of 4/18/08 are:

• Bank of America Corp.
• JPMorgan Chase & Co.
• Citigroup Inc.
• American International Group Inc.
• Wells Fargo & Co.
• Goldman Sachs Group Inc.
• U.S. Bancorp
• Wachovia Corp.
• Bank of New York Mellon Corp.
• Morgan Stanley

In the interest of full disclosure, the author of this article does not maintain any positions in any of the companies mentioned in this article.

Comments

[Publicliter...:]

2.7% to 2.9% is not that dramatic. Just a few months ago Libor was above 4%. I think banks can easily handle this rate. Homebuilders were really struggling when Libor was a lot higher, but this rate is near inflation. I don't see where the panic is. Plus, why would you single out big bank financials and not something more specific like mortgage companies?

2008 Apr 21 08:25 PM