Reader a pointed us to an article in the Financial Times which we missed over the weekend, and a quick survey of blogs suggests we weren’t alone in overlooking it.
The article addresses an issue that has not gotten much airing, namely that Libor, which is currently at elevated levels thanks to the credit crisis, actually understates bank borrowing costs. This isn’t the first time we’ve heard that, since readers in comments complained bitterly that they lost 30-40 basis points on products that were priced off Libor versus their theoretical spread. Presumably the gap between Libor and actual funding costs is even worse now.
From the Financial Times:
Banks are looking at passing on higher funding costs to corporate borrowers by invoking an extraordinary clause in loan agreements triggered by market turmoil.
A growing number of banks are concerned that Libor – a benchmark for interbank borrowing costs and the base for calculating the interest rate for many corporate loans – is no longer accurate in reflecting their actual funding costs.
Some are now considering whether they can invoke a “Market Disruption Clause” in loan agreements on certain undrawn credit facilities, allowing to charge higher interest rates to borrowers…
The move comes as banks face a growing likelihood that they may have to extend more credit to corporate borrowers because of disruptions in other markets. General Motors and Goodyear Tire & Rubber have been seen in the past few days drawing down on their credit facilities.
Libor, which has been at highly elevated levels, is the pricing base for corporate loans with lenders charging a spread or risk premium over that rate….
A potential headache for banks is that many such facilities will have been agreed before the recent worsening in credit conditions at a fixed rate over Libor that may now be lower than a bank’s all-in cost of funding that facility.
A spokesman for the LMA confirmed it planned to contact the Bank of England about concerns about Libor and that it may not represent the members’ true cost of funds, but declined to comment further.
In general, loan financings will allow a syndicate of lenders to switch the rate at which they lend to a company to a level that represents their true costs of funds, with the support of at least a third of the syndicate. But it requires banks to disclose what they believe their own cost of funding.
However, individual banks are reluctant to complain that Libor rates are too low because it is tantamount to admitting other banks view them as a risky borrower.