Auto Returns Running Over Government Rates
Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Today’s rates are ridiculously low. Take a look:
- 6-Month Government Bills yield around .13%
- 2-Year Notes return approximately .24%
- The 10-Year Note Brings in about 1.57%
- Close to 2.69% – that’s all companies are earning on the volatile 30-Year Bonds
How are company treasurers supposed to cope with this? Many companies are hoarding cash right now until they can get a more clear picture of what American business will look like over the next four years (READ: who will win the next election? Will it be Obama, who seems to want more regulation, or Romney, who communicates free capitalism?). Either way, tremendous uncertainty and low rates puts cash-rich companies in a bind. So what do they do? They go yield-seeking.
Google (NASDAQ: GOOG) announced that it has joined the ranks of 3M (NYSE: MMM) and Automatic Data Processing (NASDAQ: ADP) in investing into consumer loans – primarily auto loans and credit card debt. These companies have benefited from investing in asset-backed securities (ABS) that have smoked the yields of their AAA government counterparts. According The Wall Street Journal article:
The auto portion of an ABS index compiled by Barclays has returned 2.34% (through August 7) on deals with an average maturity of just over two years. That compares with .30% for comparable Treasuries this year.
Some yields are priced even as low as .5%, but when companies are investing between $200 million and $1 billion, even a .20% spread is incredibly material – that spread on a $500 million investment equals $1 million, 10 or 12 worker salaries. And a 2% difference on a $500 million investment? $10 million.
The juiced returns of auto loans have bolstered the debt offerings of those securities, with $60.28 billion sold through August 2.
Loan Strength
One new addition since the credit crisis – loan strength. According to the article above, today’s auto loans are backed by loans made to prime borrowers with high credit scores, and they are supported by stronger collateral. Also, the loans “are usually over collateralized. That means for every $100 of loans in the pool there may be only $85 of bonds, for example—lowering the risk those purchasers of the debt will have their payments squeezed by defaults.”
What does this mean for cash-rich companies? Hire savvy treasurers. The Wall Street Journal reports that at the end of July, 3.06% of all corporate cash portfolios were invested in ABS.
Companies like Google, 3M, and ADP have already capitalized on this trend, but two other companies should follow suit. General Electric (NYSE: GE) and Goldman Sachs (NYSE: GS) should pay special attention. General Electric is the most cash-rich company, reporting a whopping $429.5 billion in current assets as of June 29, 2012. Note that $15.4 billion of that is inventory and $291.8 billion is in receivables, but that still leaves more than $122 billion in cash and equivalents and short-term investments. Even a .1% yield boost on $122 billion would increase profits by a stunning $122 million. Wow.
And Goldman is ranked second on the cash-rich list, right above Microsoft. Goldman is in an excellent position, because it can both invest in the paper and underwrite it – essentially double-dipping. It’s similar to when banks were earning fat profits from underwriting and investing in mortgage-backed securities from 2004 – 2006, except that these consumer-backed, high-collateral securities are far more safe. In essence, Goldman has the opportunity to push these investments and profit – and also to invest its own cash hoard and profit.
In all, the message for investors is to make certain that companies are making good use of their cash hoards. Google is – it made headlines for buying debt from Honda Motor Co. and Hyundai Corp., and other firms should follow suit.
The U.S. markets are fragile right now, and a Europe flare-up or another bout of quantitative easing could push treasury prices higher and rates lower, reducing company’s profits from cash portfolios. Thus it would be a wise idea to turn away from a volatile Uncle Sam just long enough to place a small percentage of a cash portfolio in diversified loans.
ChrisMarasco has no positions in the stocks mentioned above. The Motley Fool owns shares of Google. Motley Fool newsletter services recommend 3M Company, Automatic Data Processing, Goldman Sachs Group, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
