Companies that are likely to suffer with a rise in interest rates?

[LongHaul]

I think long term rates will rise in the future and am curious which companies are likely to suffer with a rise in interest rates.

I am not sure who owns all of these 30 year mortgages at very low rates but on a mark to market basis there is a good chance they take a big hit.  Thoughts appreciated.

 

[DTEJD1997]

Hmmm:

 

Any company that has borrowed a lot of money and has to refinance it.

 

Banks, utilities, REITs, large, heavily indebted manufacturers.  Possibly large casino companies that have borrowed billions upon billions (Caesars).  What about "for profit" education?  Student loan rates almost doubled.  I very much suspect they will rise in the near future.

 

Of course, it depends on how much of a rise in interest rates we are talking about.  Interest rates moving 50 basis points probably won't have a huge long term effect.  Interest rates moving 300 basis points certainly will.

 

I am very skeptical that long term rates in the USA will move up substantially.  The government has simply borrowed too much.  How will the government service the debt if rates rise?  I don't see how they can without firing up the printing press.

[Packer16]

You also still have massive deflationary pressure from debt payoff in the private sector.  This combined  with the continued requirement for a safe place to place money from the emerging markets will keep rates low.  What will drive rates up is inflation (wage inflation specifically) and that is nowhere in sight. 

 

Historically, interest rates have an about 80-year cycle.  The last cycle was a high in 1810 to a low in 1900 to a high in 1980.  This would imply a low in about 2060.  However, many of the factors that drove these cycles are no long with us for now (wars, state-directed production methods (communism) and epidemics) so this cycle may be longer as each of these factors reduced the amount of human capital available and thus increased wages and inflation.  In either case, historically inflation (and high interest rates) looks like it is away off.

 

I think there will be an adjustment for lower QE (we may have already seen a majority of this effect already).

 

Packer

[LC]

I'm not sure if I agree that the market has priced in lower QE yet. Mcap to GNP has been increasing over the last six months. What i am looking out for is when QE does stop and those effects start flowing through the income statement.

[ragnarisapirate]

2 thoughts:

 

1) Our cycles probably move a lot quicker now due to exchange of information and such.

2) It may pay here to invert the question and ask, what companies will be at an advantage due to higher interest rates.

 

Though, in reality, these may be a hard question to address as there are a lot of variables.

[Morgan]

Any company that has borrowed a lot of money and has to refinance it.

 

Refinancing is the key part. In real estate, assuming you have fixed interest rates, the increase in interest rates should provide a minor competitive advantage over newer entrants who have to pay the higher rates. Minor and not eternal, but somewhat of an advantage.

[LongHaul]

Great chart of 10 year Treasury rate.

http://www.multpl.com/interest-rate/

 

I have no idea on the timing of rates but going back over the centuries, a real rate of 2-4% seemed to generally prevail. 

 

Great point about overleveraged companies.  They will likely have to pay much higher rates on refinancing. 

 

For discussion's sake - A 20 yr bond where market interest rates go from 4% to 7% will see it's price decline from 100 to 68 for a 32% decline.  That is enormous.  On a mark to market basis some of these highly leveraged financial companies are probably very vulnerable to interest rates rises.  I just don't know whom.  And if the financial company is leveraged 10 to 1 and has 15% of their assets in long term instruments half of its equity could be wiped out on a mark to market basis. 

 

 

[BG2008]

I remember an interview with the Coca Cola bottlers about high interest rates in the 80's.  Given that bottling is cap ex intensive and selling syrup and a brand is not, a higher interest rate hurts the bottling business.  I'm inclined to say that any business that are very capital intensive and require financing will be hurt in a rising interest rate environment.  This would put companies like construction equipment, oil rigs, etc into that category. 

 

I'm still trying to figure out what to think of real estate valuation.  In real estate, value is often determined by ability to service debt.  If a house sells for $1mm and rates were 5%, someone who can afford $50k a year in interest can afford to buy a $1mm house.  If rates goes to $10%, that same person can only afford a $500k a year.  I can see a situation where if rates were to rise sharply, commercial real estate can get hurt bad.  Most commercial loans are less than 10 years and they are not meant to amortize 100% within that 10 year time.  When rates rise, companies will struggle to refinance into a new higher rate.  Companies can run into a lot of stress when they are forced to sell.

[SharperDingaan]

Hurt from a rise; Banks, utilities, commercial real estate. Benefit from a rise; Life Coys, those with material DB pension obligations (auto, etc). Long/short combinations should more or less match term, & have the appropriate duration mismatch.

 

Higher rates reduce loan activity & hence a banks total spread earnings; raise them enough & you also get loan write-offs.

Higher rates also reduce the PV of future cash streams; the value of long term assets - & liabilities - decline.

 

SD

[beerbaron]

Highly levered companies with short term durations...

 

BeerBaron

[HJ]

I think it's a bit simplistic to just say banks will suffer if rates go up, or real estate, for that matter.  A lot depends on how it rises, is the rate rising while also steepening, or flattening, maybe it's first steepening followed by flattening as the Fed tries to catch up to the long end.  Then the question is how fast does the bank's portfolio re-price to the initial steepening move before the subsequent flattening.  The answer, of course will be that it depends on the economic forces at the time, loan demand, asset value, risk propensity of the major economic actors, etc. 

 

Rates were generally rising throughout the 60's and 70's, but bank ROE, while not spectacular, was consistently low teens, inline with other mature industries.  It's not until Volker inverted the curve, when one can definitively say it's the rates that caused the banks to go down.  Other forces had much more impact on the banking business through out that period.  Introduction of the money market fund, the reform that removed the tax shelter of commercial real estate, changes in the interstate banking laws, etc., etc. 

 

A rising rate has a dampening effect on valuation of all financial assets, including banks.  Whether it hurts a particular business fundamental aside from plain valuation also depends on how the basic economic / regulatory forces of that business interact with the rate moves at the time.