The following is reprinted with permission from HFA Partners.
The London Interbank Offered Rate, or Libor, is the rate at which banks can borrow funds from each other in the London interbank market. It is also used as a primary benchmark for short-term interest rates around the world.
Libor is calculated for multiple terms each day by the British Bankers' Association based on submissions received from 16 global banks. The four highest and the four lowest submissions are disregarded, and the final Libor rate is based on the average of the remaining eight.
As early as 2005, Barclays Bank and other banks allegedly colluded to keep Libor artificially low. Barclays has already agreed to pay $451 million in fines for submitting false rates between 2005 and 2007. Regulators think other banks may be involved and are reportedly investigating Bank of America, Citigroup, Credit Suisse, HSBC, JPMorgan Chase, Royal Bank of Scotland and UBS.
Impact on hospitals
Hospitals and other municipal borrowers could have been impacted by Libor fixing in a couple of ways.
• Hospitals that received Libor-based payments. Most pay-fixed swaps and basis swaps pay hospitals based on Libor, so an artificially-low Libor would have resulted in these hospitals receiving less than they were entitled to. Termination values would have also been negatively affected.
• Hospitals that made Libor-based payments. This includes many reverse swaps, where the hospital pays based on Libor and receives a fixed rate, but also loans indexed off Libor. A lower-than-normal Libor would have resulted in hospitals paying less, so they're probably not going to complain.
Given the popularity of swaps during the period in question, the aggregate losses across the healthcare sector could in theory be significant but will depend on the magnitude of the rate manipulation and may be partially offset by any savings that may have been achieved on Libor loan payments.
Quantifying losses
It appears that the manipulation involved very small changes to the Libor rate, reportedly as little as 1 basis point (1/100th of a percentage point). These minute changes can result in sizeable profits for traders carrying huge positions but may not mean much for the average hospital swap portfolio.
As an example, on a $50 million Libor-receiver swap, a one basis point reduction in Libor would mean $5,000 less each year. The total loss experienced by the hospital could be materially greater if the swap was terminated, since the swap's mark-to-market value would capture the present value of all future reduced cash flows. However, it is very unlikely that a manipulation of Libor is responsible for most pay-fixed swaps being under water.
Not willing to wait until more specifics are known, some industry observers have turned to SIFMA as a proxy for estimating the true Libor. Libor and SIFMA are in fact highly correlated, and the relationship between the two indexes was relatively stable between 1989 and 2008, with SIFMA averaging 72 percent of Libor. The problem is that the correlation is not sufficient to arrive at a reliable estimate of Libor, so hospitals should wait until the exact adjustments to Libor become known before attempting to calculate any losses they may have experienced.
Next steps for hospitals with swaps
Now that the evil scheme is exposed, banks will be on their best behavior, so there is little reason for hospitals to be concerned about not getting adequate Libor payments going forward. Given how far under water most pay-fixed swaps are, unwinding these positions out of such concern would not be well-advised.
With respect to recouping past losses, unless the manipulation turns out to be much more than a few basis points, the average hospital or small health system may not have much of a claim, particularly if savings from Libor-based loans offset losses on swaps.
Hospitals with large pay-fixed swap portfolios and those that terminated pay-fixed swaps in the last several years may have more at stake and should monitor the situation closely. Once the magnitude of the rate manipulation is known, calculating the impact on swap cash flows should be relatively straight forward. The impact on termination values will be a little more complex to estimate with a swap valuation model.
Only then will hospitals be in position to determine accurately how the rate fixing may have impacted their financial performance.
HFA Partners is an independent financial advisory firm helping hospitals and healthcare providers lower the cost of debt and reduce balance sheet risk.
The London Interbank Offered Rate, or Libor, is the rate at which banks can borrow funds from each other in the London interbank market. It is also used as a primary benchmark for short-term interest rates around the world.
Libor is calculated for multiple terms each day by the British Bankers' Association based on submissions received from 16 global banks. The four highest and the four lowest submissions are disregarded, and the final Libor rate is based on the average of the remaining eight.
As early as 2005, Barclays Bank and other banks allegedly colluded to keep Libor artificially low. Barclays has already agreed to pay $451 million in fines for submitting false rates between 2005 and 2007. Regulators think other banks may be involved and are reportedly investigating Bank of America, Citigroup, Credit Suisse, HSBC, JPMorgan Chase, Royal Bank of Scotland and UBS.
Impact on hospitals
Hospitals and other municipal borrowers could have been impacted by Libor fixing in a couple of ways.
• Hospitals that received Libor-based payments. Most pay-fixed swaps and basis swaps pay hospitals based on Libor, so an artificially-low Libor would have resulted in these hospitals receiving less than they were entitled to. Termination values would have also been negatively affected.
• Hospitals that made Libor-based payments. This includes many reverse swaps, where the hospital pays based on Libor and receives a fixed rate, but also loans indexed off Libor. A lower-than-normal Libor would have resulted in hospitals paying less, so they're probably not going to complain.
Given the popularity of swaps during the period in question, the aggregate losses across the healthcare sector could in theory be significant but will depend on the magnitude of the rate manipulation and may be partially offset by any savings that may have been achieved on Libor loan payments.
Quantifying losses
It appears that the manipulation involved very small changes to the Libor rate, reportedly as little as 1 basis point (1/100th of a percentage point). These minute changes can result in sizeable profits for traders carrying huge positions but may not mean much for the average hospital swap portfolio.
As an example, on a $50 million Libor-receiver swap, a one basis point reduction in Libor would mean $5,000 less each year. The total loss experienced by the hospital could be materially greater if the swap was terminated, since the swap's mark-to-market value would capture the present value of all future reduced cash flows. However, it is very unlikely that a manipulation of Libor is responsible for most pay-fixed swaps being under water. Not willing to wait until more specifics are known, some industry observers have turned to SIFMA as a proxy for estimating the true Libor. Libor and SIFMA are in fact highly correlated, and the relationship between the two indexes was relatively stable between 1989 and 2008, with SIFMA averaging 72 percent of Libor. The problem is that the correlation is not sufficient to arrive at a reliable estimate of Libor, so hospitals should wait until the exact adjustments to Libor become known before attempting to calculate any losses they may have experienced.
Next steps for hospitals with swaps
Now that the evil scheme is exposed, banks will be on their best behavior, so there is little reason for hospitals to be concerned about not getting adequate Libor payments going forward. Given how far under water most pay-fixed swaps are, unwinding these positions out of such concern would not be well-advised.
With respect to recouping past losses, unless the manipulation turns out to be much more than a few basis points, the average hospital or small health system may not have much of a claim, particularly if savings from Libor-based loans offset losses on swaps.
Hospitals with large pay-fixed swap portfolios and those that terminated pay-fixed swaps in the last several years may have more at stake and should monitor the situation closely. Once the magnitude of the rate manipulation is known, calculating the impact on swap cash flows should be relatively straight forward. The impact on termination values will be a little more complex to estimate with a swap valuation model.
Only then will hospitals be in position to determine accurately how the rate fixing may have impacted their financial performance.
HFA Partners is an independent financial advisory firm helping hospitals and healthcare providers lower the cost of debt and reduce balance sheet risk.
More Articles From HFA Partners:
How Does the Libor Scandal Affect Hospitals?
New Bad Debt Accounting May Impact Hospital Bond Covenants
What Moody's Bank Downgrades Mean for Hospitals