By Jack Hough
Mark Zuckerberg uses an adjustable-rate mortgage. Should you? Probably not.
When the billionaire Facebook founder refinanced his mortgage with First Republic Bank earlier this year, he scored an adjustable-rate loan that started with a 1.05% rate in May, according to Bloomberg. The rate resets monthly and is equal to the London Interbank Offered Rate, or Libor, plus 0.8 percentage points. The one-month Libor rate was recently 0.25%.
By one measure, the loan is so cheap that Mr. Zuckerberg is making money on it. The inflation rate was 1.7% over the year through May, according to the Labor Department. That’s a modest rate by historical standards, but nonetheless, it’s high enough to suggest that the dollars Mr. Zuckerberg owes are losing value faster than his loan is accruing interest.
A one-month adjustable-rate mortgage is a niche product available only to the wealthy, says Greg McBride, a senior financial analyst at Bankrate.com. But one-year ARMs are common enough that rates for them are tracked by mortgage specialist Freddie Mac. The latest rate is 2.69% — safely above the inflation rate.
So how did Mr. Zuckerberg score such a low rate? By posing near-zero credit risk. First Republic currently pays little to attract deposits. It latest published rate for a three-month certificate of deposit is just 0.05%. With funds that it doesn’t use for conventional lending, it can invest with negligible credit risk by buying, say, U.S. Treasury bills. But three-month ones recently paid just 0.06%.
For Treasury-like safety with a much higher return, the bank can instead make a collateralized loan of just under $6 million to someone who is worth nearly $16 billion, which is what it did. Mr. Zuckerberg may be making money on his loan, but so is First Republic, because it can raise money at rates that make 1.05% look lavish.
For homebuyers who would have to pay mortgage rates closer to national averages, ARMs don’t hold much appeal at the moment. Their rates have fallen more slowly of late than those of fixed-rate mortgages. The 30-year fixed mortgage rate recently averaged a record low of 3.56%, down nearly a full percentage point from 4.51% a year ago. That 2.69% rate on a one-year ARM, meanwhile, has fallen by only around one-quarter of a percentage point, from 2.95% a year ago.
Also, ARMs save borrowers less cash than they have in the past. The difference between the one-year ARM rate and the 30-year fixed rate is just 0.87 percentage points. Over the past 20 years, it has averaged 1.61 percentage points.
That’s a minimal savings compared with the added risk of a rise in interest rates from current lows during the next 30 years. The only kind of borrower who doesn’t have to worry about such a thing is one who has enough money to pay his loan in full whenever he pleases. It also helps if he, like Mr. Zuckerberg, can negotiate a rate that is safely below the inflation rate. Those who are borrowing because they need the money, meanwhile, should stick with fixed rates.

via blogs.smartmoney.com

Calif. Bankruptcies Still Outliers, but Fresno Troubled Too | Bedford Realtor

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By Michael Aneiro
With three California cities opting to file for bankruptcy protection within the past month, many are worrying this could open the floodgates to more municipal bankruptcies. But Citi strategists say the bankruptcy option still brings enough stigma and costs to deter other troubled cities.
Citi notes that the cases of Stockton, San Bernardino and Mammoth Lakes are more or less outliers, with typical municipal issuers tending to be much more financially disciplined. But other California issuers share similar problems, such as weak revenues from property, sales, and personal income tax, as well as high employee salary and pension fixed costs. Citi says California’s Proposition 13, which caps property taxes, has also hamstrung the state.
As this week’s Barron’s wrote, some market observers worry that there’s suddenly less stigma associated with filing for Chapter 9 bankruptcy, the muni equivalent of Chapter 11, which could encourage its use by other cities facing revenue shortfalls and heavy debt loads, or as a tool to renegotiate collective bargaining agreements. Not so fast, argue Citi strategists George Friedlander, Mikhail Foux and Vikram Rai:
We strongly disagree with this view and caution against this option as the cost of a chapter 9 filing remains harsh, with a near-certain lockout from access to capital markets, high litigation costs, and an uncertain outlook for governments and governmental employees once the Bankruptcy judge takes over. Access to capital markets to fund cash flow shortfalls (via BANs/RANs/TRANs) remains critical for maintaining key government functions and continuation of essential services.
Citi says the spotlight has now shifted to Fresno, Calif., which it says also suffers from a high fixed costs and limited financial flexibility, as well as “excessive exposure” to a fragile economy. While the city has a well-funded pension plan, Citi says its revenue options are limited, forcing an over-reliance on spending cuts at a time when most services are already reduced. Moreover, Citi says long-term labor contracts with the police union have locked in compensation costs “at a level that no longer appears sustainable” amid weak revenue performance.
Despite all this, Citi notes that yields on California state general obligation bonds have yet to show any impact. Citi adds that fears of contagion remain limited and any market impact should remain isolated to weaker credits with specific budget shortfalls. More from Citi:
We believe that contagion on overlapping credits such as counties, school districts revenue bonds backed by “special revenues” resulting from the association with the problem credits could create some attractive values. Both market psychology and rating agency actions on these associated credits could cause trading levels to weaken in a number of cases, despite the likelihood that these credits will generally maintain their capacity to pay debt service.

via blogs.barrons.com