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Falling Out Of Context (US Treasury Historical Data)

|Includes: Ares Capital (ARCC)

To a larger degree than average - I live in my own world and have no idea what the rest of earth's inhabitants are thinking. I perceive that the way things are (chaotic, uncertain, predominantly filled with an absence of optimism) - are the ways they have always been. I forget that things have been very different.

BDCs have shift to having high weightings in floating rate loans. It is my perception that those loans float based on the 30 day LIBOR rate. I could probably find historical data on those rates - but I knew I could quickly find data on 30 day US treasuries.

I had (up until this morning) the impression that those rates were microscopic - and had always been that way. Thus it was highly unlikely that a change in those rates would meaningfully impact the earnings of BDCs.

After looking up the data - I am changing that impression from "highly unlikely" to just "unlikely" - but happening often enough that the floating rate attribute has the potential to be meaningful. The data:

Historical Beginning of the year Yields of the US Treasury

Year 3 Month Change 5 Year Change 10 year Change
1991 6.66   7.59   7.97  
1992 3.96 270 6.46 113 6.78 119
1993 3.19 77 5.90 56 6.60 18
1994 3.16 3 5.29 61 5.92 68
1995 5.95 279 7.88 259 7.88 196
1996 5.20 75 5.39 249 5.60 228
1997 5.19 1 6.30 91 6.54 94
1998 5.32 13 5.62 68 5.67 87
1999 4.49 83 4.57 107 4.69 98
2000 5.48 99 6.50 193 6.58 189
2001 5.87 39 4.76 174 4.92 166
2002 1.74 413 4.52 24 5.20 28
2003 1.22 52 3.05 147 4.07 113
2004 0.93 29 3.36 31 4.38 31
2005 2.32 139 3.64 28 4.23 15
2006 4.16 184 4.30 66 4.37 14
2007 5.07 91 4.68 38 4.68 31
2008 3.26 181 3.28 140 3.91 77
2009 0.08 318 1.72 156 2.46 145
2010 0.08 0 2.65 93 3.85 135
2011 0.15 7 2.02 63 3.36 49
2012 0.02 13 0.89 113 1.97 139
2013 0.08 6 0.76 13 1.86 11
2014 0.07 1 1.72 96 3.00 114
2015 0.02 5 1.61 11 2.12 88
2016 0.17 15 1.73 12 2.24 12

source: https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yieldYear&year=1999

I am quickly becoming an old fart. I did have memories of short term rates being decent in the 80s. I would call a 5% yield 'decent' - and that has happened as recently as 2007. I had fallen out of touch with the historical context - and that was leading to a bad call on the importance of the floating rate attribute.

I had the impression that interest rate volatility would always be higher for the 10 year than the three month maturity - and that the difference would be substantial. The historical data indicates that such an impression is 50 shades of wrong.

And now for the data from ARCC (which I suspect is typical for the BDCs in general) on the impact of 100 bps shifts in interest rates:

Up 300 basis points --$149.8 million

Up 200 basis points -- $89.9 million

Up 100 basis points -- $30.0 million

Down 100 basis points -- $14.3 million

Down 200 basis points -- $14.1 million

Down 300 basis points -- $14.1 million

source: http://www.arescapitalcorp-ir.com/Cache/35355546.pdf?IID=4092627&FID=35355546&O=3&OSID=9

Hint to finding data - do a word search for "basis points"

So a 100 bps change in yields would have a $30 million impact on net income or NII. Given that there are 314 million share outstanding, this comes to 9 cents per share. With 2016 NII having a consensus projection of $1.53/share - a 9 cent increase would be meaningful.

Current expectations are for the Fed to move in 25 bps increments. Four increases would result in a 100 bps move. There is a decent probability that the LIBOR moves will mirror the Fed moves (but I still would like to see that data, so that I could have confidence in that expectation).

I previously wrote that float rate loan interest rate changes would most likely be immaterial. After looking at the data - I have changed that impression.

Disclosure: I am/we are long ARCC.