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LIBOR Reaches Historic Lows |
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July 27, 2009
Media around the world have been reporting record lows reached in a number of LIBOR indices, particularly those based on the U.S. Dollar and Euro. The 3-Month Dollar LIBOR and the 3-Month Euro LIBOR have both recently made historic drops.
Experts say that the declines in interbank lending rates constitute approval of central bank efforts to bolster global economies. In the U.S., such efforts are seen in policies to keep Fed rates at ultra-low levels of 0 to .25%. In Europe, the European Central Bank is infusing a record amount of cash into the financial system to stimulate lending to consumers and companies. In the end, banks are showing their bullishness by lowering rates for their brother banks, which should ultimately translate into lower cost of funds and more available credit across the borrowing spectrum.
We asked LIBORATED.com founder Paul Wylie about LIBOR’s new lows and what they mean to borrowers looking to purchase real estate or expand their small businesses.
What do you anticipate for LIBOR levels?
I anticipate very low LIBOR values for the remainder of this year and well into next year. The central banks have stabilized the financial systems worldwide and restored confidence. In the USA, banks can currently borrow overnight from the Federal Reserve Bank at an annualized rate of approximately 0.14% (14 basis points) or a little more than 1 basis point per month. The one month LIBOR is currently at approximately 0.28% which provides a 100% mark-up for very short (one month) duration risk. Deflation currently poses a far greater risk than inflation which is keeping LIBOR low.
The largest cost in the USA for most businesses is labor and that cost has been reduced as a result of the recession. Even when recovery starts, employment historically trails, causing labor costs to stay in check. The second biggest source of expense for most companies is occupancy. Businesses have been downsizing their space and/or renegotiating their lease rates with landlords, which in turn reduces the value of commercial real estate. This too has a deflationary effect contributing to keeping LIBOR low.
What does the current low LIBOR mean for borrowers?
Directly and indirectly it is great for almost everyone. Directly consumers are impacted by automobile loan rates, charge card rates, and mortgage reset rates (currently lower than most original rates). On the indirect level, most companies have debt. More and more of that debt is tied to LIBOR. The lower LIBOR is the lower the cost for companies which means companies can keep their overall costs down which are passed through to consumers not only for financial products, but automotive, insurance, travel (Southwest Airlines), and even food (The Cheesecake Factory).
How can small business owners take advantage of today’s low LIBOR to plan for long-term competitive advantage?
They can interview banks to negotiate the best rates and terms. They can borrow at very favorable rates and terms to restructure existing debt and/or expand to take market share and/or start a new business line.
What effect does today’s LIBOR levels have on home loans?
Most resets are tied to LIBOR. Those reset rates are generally lower than the original rates. Consideration can be given to buying a luxury home with a jumbo LIBOR loan that currently has an Annual Percentage Rate (APR) of 1.875%. The home could be used as a principal residence, second home, or as a rental with tremendous positive cash flow. LIBOR loans rarely have a prepayment penalty so when they go up in rate they can be refinanced if desired. The jumbo secondary market will return when home values and the economy stabilize (estimated at1-2 years). Most borrowers are choosing a low fixed rate, which is the best choice for most people. However, for jumbo loan borrowers, being an informed and focused contrarian has a high probability of being amply rewarded.
How can borrowers integrate an understanding of LIBOR into their loan strategies?
This can be achieved by spending time reading at LIBORATED.com, Wikipedia, and the BBA's website.