The scandal surrounding the London interbank offered rate is threatening to undermine confidence in syndicated loans and hasten companies’ flight to bonds.
“What corporate treasurers are concerned about is the damage this Libor problem will do to market confidence,” said John Grout, the policy and technical director at the Association of Corporate Treasurers in London, which has about 4,500 members. “If people lose trust in banks and Libor, which is indexed to a huge amount of debt and derivatives instruments, market liquidity could be reduced and borrowing costs could rise for corporates.”
Corporate loans typically pay interest pegged to Libor or its equivalents in other currencies, and the rate-rigging scandal is spreading uncertainty about whether the benchmarks reflect lenders’ true cost of funding. At least a dozen banks are being investigated for manipulating Libor, prompting Barclays Plc Chief Executive Officer Robert Diamond to quit last week after the U.K.’s second-biggest lender was fined a record $451 million.
Loans are already on the wane as a funding option for companies in the U.S. and Europe. More stringent capital requirements introduced by regulators to prevent the risky lending practices that exacerbated the financial crisis have made it more expensive for banks to extend loans, and prompted lenders in Europe to pledge more than $1 trillion of balance-sheet cuts.
Non-financial companies in the U.S. borrowed $483 billion through syndicated loans and credit lines this year, a 13 percent drop from the same period of 2011, while in Europe volumes fell 25 percent to $322 billion, data compiled by Bloomberg show.
Loans were overtaken by bonds for the first time in Europe this year, according to Fitch Ratings. Bond issues made up 52 percent of the 467 billion euros ($575 billion) of new corporate funding in the first half, compared with 29 percent for the whole of 2011, the New York-based firm said in a July 3 report.
“Before 2007 our borrowings were linked to base rate not Libor, but then banks insisted we move to a Libor-rated margin as we were told it was market practice,” said Ben Whawell, the chief financial officer at Warrington, England-based trucking and warehousing company Stobart Group Ltd.
“The last week hasn’t changed anything as far as banks are concerned,” he said. “They’re all in it to make money and they’ll take any opportunity they can to charge you a fee.”
Clare Dawson, the managing director of the Loan Market Association in London, said Libor would continue to be the benchmark for the syndicated loan market.
“Libor is only one factor that people are looking at when they look at a loan, either as a means of raising finance or as an investment,” said Dawson, whose group represents 486 banks, investors and law firms. “I see no reason why a floating-rate debt product won’t continue to be a key component of the financing market, and clearly most floating rate loans are based off Libor or Euribor.”
Libor is calculated from a daily survey carried out for the British Bankers Association in London, in which the world’s biggest lenders are asked the rate they’re charged to borrow over a variety of short-term maturities in currencies including dollars, euros and yen. Banks are accused of massaging down submissions for the benchmark for $360 trillion of global securities during the financial crisis and artificially increasing them before it.
The so-called lowballing may have more impact on lenders’ returns in Europe than in the U.S., where they’ve been quicker to adopt Libor floors that set a minimum level for the benchmark. The main three-month dollar Libor rate held at 0.458 percent today, compared with 5.724 percent in September 2007.
“In the wake of this scandal, we’re worried that more banks will stop submitting rates to BBA because of the legal cost and controversy involved,” said Grout, formerly finance director of Cadbury Schweppes. “That won’t be helpful.”