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

[What do I k...:]

I'm a fan of SKF, too. But I'm nervous that all this market nonsense will continue until my SKF is virtually worthless. It makes no sense to me, but this feels like a prolonged rally of sorts, although not a rocket. I just can't see how the market is going up under such circumstances.

2008 Apr 21 03:23 PM

[Ryan Freund:]

Take solace in the fact that bank earnings have been severely hampered by the reduction of business. Add to that the reduction in leverage (and the resulting increase of reserves) and banks are still too richly valued. Future quarters will reveal the truth that the market makers are trying to hide.

2008 Apr 21 04:33 PM

[jjason:]

I wish the public would complain to their Congressman and Senators and ask that short selling be made illegal. I invest in US stocks for income from dividends and to receive profits (from capital gains) in the future. You short sellers help to drive stock prices down and your sole contribution to our economy is gambling. What do we get from the gambling industry? Gambling does not put food on our table, gas in our cars or money to send our kids to college. Most gamblers LOSE money. As Buffet has said " Invest in an index fund or a mutual fund a little at a time and in 40 years you will have a nice increase in the value of your investment".

Finally, Congress has recently asked the SEC to investigate naked short selling. I hope the SEC does this and puts those involved in naked short selling in jail.

Our economy does not benefit from short selling. You do not PRODUCE anything by being involved in short selling. Get it?

2008 Apr 22 06:39 AM

[Ryan:]

You're wrong. Short selling kills bad companies quickly.

2008 Apr 22 01:03 PM

[Walt/frustr...:]

I agree completely, why are such companies such as Citigroup, JPMorgan etc. taking such a long time in going down?
I bought calls in SKF and puts in C and a while ago and am still in the hole because of premiums, and they just languish. Time will run out!!!

2008 Apr 22 02:58 PM

[Ryan:]

I'm with ya Walt. They are on life support from the Fed and preferred offerings. Earnings will decline dramatically and eventually the market will value these companies much lower.

2008 Apr 23 06:30 AM