Time to Rein in the Leverage?

Time to Rein in the Leverage?

In a recent interview, Warren Buffett shared the wisdom from Berkshire Hathaway Vice Chairman, Charlie Munger.  “My partner Charlie says there is only three ways a smart person can go broke: liquor, ladies and leverage”, he said.  “Now the truth is – the first two he just added because they started with L – its leverage”.

Buffett shared data revealing Berkshire Hathaway’s share price had declined by between 37 per cent and 59 per cent on four occasions over four decades, as follows:

And in a world where many think interest rates will remain close to historical lows and given its approaching 27 years, Australia will not experience another recession, I thought I would use this blog to briefly explore the LIBOR (London Interbank Offered Rate) market – the most common of global benchmark interest rate indexes in which adjustments are made to variable mortgage rates.

LIBOR is the average of interest rates estimated by each of the leading banks in London that it would be charged were it to borrow from other banks. LIBOR rates are charged for five currencies (US$, Euro, British Pound, Japanese Yen and Swiss Franc) and seven borrowing periods ranging from one day to one year (one day, one week, one month, two months, 3 months, 6 months, 12 months) and are published each business day.

Many financial institutions, mortgage lenders and credit card agencies set their own rates relative to it, and at least US$350 trillion (about 3X the global GDP) in derivatives and other financial products are tied to it.

In the past three years, the US$ LIBOR interest rate with three-month maturity has risen steadily from 0.25 per cent to the current 2.20 per cent, and in the past twelve months it has risen by over 1.0 per cent. In short, the cost of funds for private debtors (variable mortgages) and public debtors (issuers of bonds) is going up.

Due to the exceptionally high demand for debt, a further steady increase in the LIBOR rate over the next couple of years is a possibility most leveraged players have not considered.

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Chief Executive Officer of Montgomery Investment Management, David Buckland has over 30 years of industry experience. David is a deeply knowledgeable and highly experienced financial services executive. Prior to joining Montgomery in 2012, David was CEO and Executive Director of Hunter Hall for 11 years, as well as a Director at JP Morgan in Sydney and London for eight years.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.