A Big Bang For BorrowersKathleen Madigan
Refi madness is sweeping America. From Boston to San Francisco to Washington, corporations, homeowners, and governments are rushing to refinance debt, borrow new money, and cash in on the bonanza created by a four-month plunge in interest rates. Coming all at once, the flurry of activity is great news for an economy struggling to surge ahead. Indeed, lower rates are likely to boost growth faster than President Clinton's $31 billion stimulus plan ever could.
Take Kevin and Cathy Iannucci. They're a good example of what mortgage bankers are calling "refi junkies." In November, 1991, the Nutley (N.J.) couple refinanced their 30-year mortgage of $118,500 from a rate of 10.25% to 9.12%, saving $120 a month. Now, they're doing it again, switching to an adjustable-rate loan with a first-year rate of 4.75%. The couple doesn't know how much they'll save, but they guess it will be about $320 a month. The problem, Cathy says, is that "the mortgage agent's monthly payment tables didn't go as low as 4.75%."
Some problem. Companies such as Dr Pepper Bottling Holdings Inc. are getting just as big a bang out of lower rates. The Dallas-based Dr Pepper and 7 Up bottling company will save about $4 million in cash annually after replacing its high-rate notes with new debt--money that chairman Jim Turner says he will use to pay down debt and fund acquisitions.
The rash of refinancing is helping to keep worrisome economic news, including a recent drop in consumer spending, at bay. Meanwhile, lower inflation expectations and Clinton's deficit-reduction plan have pushed the yield on a 30-year Treasury bond to 6.78%, down from 7.69% in early November (chart). That has the Clinton Administration, once worried about the economic sting of proposed tax hikes, breathing sighs of relief. "We anticipated a lowering of the interest rates," says Treasury Secretary Lloyd M. Bentsen, "but in all candor, it has been more than we expected."
BREATHING ROOM. Much more. The drop-off in rates could add almost $100 billion to the economy by 1994, or one-half of a percentage point more in growth each year, says DRI/McGraw-Hill. According to David Wyss, a DRI economist, here's how the bounty will be divvied up: $20 billion will be spent on home building, while businesses will invest the same amount in new plants and equipment. And because low rates mean a weaker U.S. dollar, exports should increase by about $10 billion, while more expensive imports will fall $15 billion. The growth in housing, capital-equipment, and exports means a rise in jobs and income. That should leave consumers with an extra $30 billion for spending.
But that's two years away. The immediate bang is the cash windfall from lower-cost corporate debt and home mortgages. The Mortgage Bankers Assn. says that the latest refinancings and the lower monthly payments for adjustable-rate loans will save homeowners some $22 billion a year--on top of the $18 billion they're already saving from 1992's lower rates.
Businesses, meanwhile, now need to use only 19.6% of their cash flow for their net interest payments, down from a peak of 28.7% in late 1989, says Regional Financial Associates, an economic consulting firm. Total savings: some $30 billion annually. And there's better news to come. RFA figures the ratio could fall to as low as 15% by mid-1993--the smallest business debt burden since the early 1980s. "We're looking at our portfolio on a daily basis to see if there's any more cost we can squeeze out," says Ralph T. Brandifino, chief financial officer of Long Island Lighting Co.
Companies are using the extra money to gain financial breathing room and to hold the line on prices. Asarco Inc., for one, is turning $100 million of short-term IOUs into long-term bonds. Although the new debt has a higher interest rate of 7.38%, a spokesman for the mining company says the switch "gives us more flexibility on our balance sheet and in our planning."
Hawaiian Electric Industries Inc. already freed up about $500,000 last year from refinancing some old bonds. Then on Mar. 1, it applied for a new, $110 million note offering. Paul A. Oyer, treasurer of HEI's utility subsidiaries, says about $100 million more debt could be refinanced at today's rates, saving upward of $2 million a year. HEI utility customers may benefit. "The savings can be meaningful and will be passed on to customers," Oyer promises.
HARD HIT. Need some good news about government? It's in for a windfall, too. Not only will the Treasury Dept. save $80 billion from the lower cost of borrowing over the next five years, but it gains on the tax side as well. That's because homeowners and companies will have smaller interest deductions. Strapped states and municipalities stand to gain, too. With tons of bonds outstanding at 6.5% to 7.5%, says Jerome J. Jacobs, vice-president of the fixed-income group at Vanguard Group, based in Valley Forge, Pa., "an astronomical amount of muni debt becomes economical to refund," if rates fall. Refundings could lift muni volume in 1993 close to 1992's record $235 billion, analysts say.
There are those who don't gain from falling rates. For now, banks are enjoying a runup in the value of their large bond portfolios--a big boost to profits. And low rates reduce the risk of defaults. If rates stay low, though, banks won't find many safe, high-yielding bonds. That means they'll either have to accept lower returns, or make riskier loans. Insurance companies and pension funds also must rethink their long-run investment strategies.
Hardest hit of all may be investors, particularly the elderly, who depend on fixed-income funds. In some cases, their incomes are dropping fast. Take Roselyn Ratner. Low rates and the calling of her long-term bonds will mean a 30% reduction in monthly interest income for the 80-year-old widow. "It's going to mean a change in my lifestyle," she frets from her home in Hollywood, Fla.
How long can rates stay low? A long time, say economists, who argue that a modest economic upturn will keep inflation down while Clinton's deficit plan may cut Washington's appetite for new borrowings. Chris P. Varvares, an economist at Larry H. Meyer & Associates, is forecasting a 30-year bond yield of 6% by the end of 1994.
That's great news for borrowers. With so many indulging in a craving for low rates, refi madness is a habit America clearly doesn't want to kick.
Kathleen Madigan with Suzanne Woolley in New York, Sandra Atchison in Denver, and bureau reports