The Fed’s Near-Zero Interest Rate Policy: A 2 Edged Sword for Senior Living
It is now clear to all that the Federal Reserve is determined to keep interest rates low for an extended time frame. In fact, we now know that ZIRP (Zero Interest Rate Policy) will continue until the Fed is satisfied that unemployment has receded to an acceptable level. Currently, the national unemployment rate is close to 8%, a level the Fed deems unacceptable. Recent statements by Fed members and associates have indicated that perhaps the rate would have to fall to 6.5% for policy to change. With the current rate of job growth barely high enough to simply accommodate new workers entering the labor force, it could be some time before the Fed changes policy. The Fed itself has indicated it could be as far off as 2015.
Is ZIRP good for not-for-profit senior living providers?
On the one hand, it is very good because it has dramatically lowered the cost of capital in the tax exempt municipal bond market. The Fed’s programs (Operation Twist and QE3) involve buying lots and lots of US Treasury and US Agency mortgage backed bonds. With a whale such as the Fed in the market buying bonds left and right, the yield on such bonds has nowhere to go but down. How does this impact the high yield municipal bond market? First of all US Treasury bonds serve as a benchmark for all other US interest rates, including municipal bonds in general and high yield bonds in particular. The linkage between high grade munis and US Treasury bonds can be strong but is not always so due to a variety of factors including supply and demand for munis, proposed tax changes, perceived credit worries and seasonal factors. The linkage between US Treasury bonds and high yield muni bonds is not as strong as for high grade municipals, but there is still a correlation between the two. So the Fed’s action in the market has had some impact on high yield muni yields.
There is another byproduct, however, to ZIRP. By keeping the riskless rate at zero, the Fed is encouraging investor to move out on the “risk curve”. Pension funds, endowments, insurance companies, ultra-rich individuals, super wealthy people, merely wealthy and on down the line to anyone looking for additional income on invested cash, are all on a hunt for yield. As a result, corporate bonds have been a hot item and the spread between corporate bonds and government bonds has narrowed. Further down the food chain (or further out on the risk curve), there has been more demand for high yield bonds and these spreads have also narrowed. The same is true for municipal bonds. As investment grade bonds have fallen in yield to the mid 3s, there has been heightened interest in high yield muni bonds. According to a recent article in the Bond Buyer, high yield funds have seen a disproportionate share of new cash flowing into the municipal market. The Bond Buyer cited one source who observed that despite muni high yield representing only 12% of the total muni market, approximately one third of all new inflows has been to muni high yield bond funds, which account for almost 85% of all high yield purchases. The biggest sectors in muni high yield, according to another source quoted in the article, are tobacco securitizations, airline bonds, nursing home and life care, and “dirt” bonds, which are project oriented real estate development bonds. There has been very little in the way of new supply in all of these sectors, with the exception of CCRC project bonds. This is a boon for providers who need to refinance or start new projects.
The downside to ZIRP? Clearly it is the lack of super-safe yield available in the investment markets. This not only impacts investment income from entrance fee funded investment portfolios, it has had a significant impact on residents and prospective residents, some of whom must now struggle to meet ever increasing financial demands within the context of a lower income environment.