We know that JPMorgan is not substantially increasing lending anytime soon. And we also know that banks are recapitalizing courtesy of a steep yield curve and near zero rates, what I would call free money. What I didn’t know is how free these funds truly were. An investor friend pointed out something curious buried deep in JPMorgan Chase’s financial report from Q1 2010, namely that they were effectively paid five basis points to borrow money.
Here’s a close-up of the numbers in question.
This is on page five of the document embedded below. It shows you that JPMorgan Chase earned an average yield of 3.24% more on its assets than it paid out on its liabilities. This huge margin is in large part due to a steep yield curve and zero rates. The interesting bit is highlighted in red. That is the interest rate that JPM had to pay for Fed Funds i.e. for money borrowed from the Federal Reserve.* The number is –0.05%. That’s right, negative 0.05% for what were $271.9 billion in repo liabilities. That’s unbelievable!
*Technically, JPMorgan borrowed from other primary dealer repo counterparties; see note at bottom.
JPMorgan Chase says in the footnote that this:
Reflects a benefit from the favorable market environment for dollar-roll financings in the first quarter of 2010 and the fourth quarter of 2009.
Favorable indeed! But how favorable? Let’s take a look at past JPM filings to see.
JPMorgan Chase does this earnings release financial supplement the same way every year. And it has the last five years’ worth online, which I consulted. Here’s what I found.
You can see how the yield spread has steadily increased over the past six years to where JPMorgan Chase is now making a spread that is 1 1/2% greater than it was in 2004.
Moreover, the interest it has paid on repos has plummeted. Fed Funds rates started coming down in mid-2007 when the subprime crisis blew up, but they fell off a cliff after Lehman hit the wall in September of 2008. As of Q1 2010, JPMorgan Chase was being paid to borrow $271 billion. Talk about free money! I sure wish I could get a deal like that.
Hat tip, Scott.
Update: The point I am trying to make is that the interest carry is enormous and that banks are borrowing for next to nothing. It just so happens that JPM’s dollar-rolls made the net rate come out negative which makes this example all the more pointed.
A commenter felt my reference to borrowing "from the government" was misleading. I have stricken that reference now. Note that technically Repo counterparties are largely banks lending and borrowing excess reserves from one another. So, they are not really borrowing from the government. However, the Fed has set the Fed Funds rate at 0.00-0.25%. It controls the Fed Funds rate to within that range by making repurchase and reverse repo agreements that are collateralized loans to primary dealers of Treasury securities. The supply and demand dynamics in the repo market are largely controlled by the Fed in order to maintain the repo rate at the specified level set by the Fed.
So, while the repo market participants may be borrowing from each other, in essence they are borrowing from the Fed. The repo rate is set and controlled by the Federal Reserve. You could suspend all counterparty transactions in the market and have dealers just repo with the Fed and the net effect would be the same.
*And I know some people argue that the Federal Reserve is not a part of the Government because the U.S. Government does not own shares. But, all profits after payments are paid to the Federal Government and the Federal Reserve is acting on behalf of the Federal Treasury.
Also note that not all repo agreements are for Treasury securities. Other collateral can be used in interbank transactions, while the Federal Reserve had only accepted Treasuries before it relaxed standards in the wake of the Lehman collapse.