First in the Series: Major Head Winds Confronting Banking Industry

Libor Scandal Threatens Major U.S. and Global Banks
by Gene Kirsch

The LIBOR rate-rigging scandal threatens to engulf some of the major banks in the world including JPMorgan Chase (JPM) and Citigroup (C) in the U.S. and, of course  Barclays, PLC (BARC.LN) in the United Kingdom.

LIBOR is an acronym for London Interbank Offered Rate.  It’s a benchmark interest rate that affects how consumers and companies borrow money across the world.

The LIBOR rate is set each week by the British Bankers’ Association (BBA) an industry group in London.  Each weekday, leading banks around the world submit a rate estimate for borrowing funds from other banks.  The BBA throws out the highest and lowest 25 percent of submissions and averages the remaining rates.  This establishes the LIBOR which is then calculated for 10 different currencies and 15 borrowing periods or terms such as for one-month, three-months or one-year rates.

LIBOR is the benchmark used to set interest rates for an estimated $350 trillion financial instruments globally, including derivative swap transactions, futures contracts, home mortgages and even some credit cards.  Lenders use the LIBOR as a base and add additional interest to cover anticipated borrower credit risk.  They may also add additional interest to reach the bank’s own profit targets.    Many variable mortgage and credit card interest rate adjustments are triggered and set based on changes in the LIBOR rate.  When the LIBOR goes up, rates and payments on loans tied to it, rise too.

A majority of variable-rate commercial loans are tied to the LIBOR.  In fact, about 45 percent of prime mortgages and 80 percent of subprime adjustable rate mortgages in the United States have interest rates based on the LIBOR.  And, about half the variable-rate private student loans are tied to the LIBOR.   

While it is not clear exactly what caused regulators to investigate Barclays Bank, PLC now, there have been suspicions for some time that banks were submitting false rates to increase their own profits.  In fact, regulators may have known as far back as 2008, but it has taken this long for them to close in on what was going on.

What Barclays did was have its trading unit convince employees responsible for submitting LIBOR rates to alter the bank’s rates based on their derivative trading positions. Traders even coordinated with other banks to lower rates as well.  During the height of the financial crises, Barclays submitted artificially low rates to give the impression that the bank could borrow money more cheaply and was healthier than it was. The three-month Libor was set at or above 5.25% during the crises, but might have been higher in reality. The current three-month LIBOR is at 0.47%, as of July 18, 2012.

Barclays was investigated, and in June the bank was found guilty and fined over $450 million for manipulating the LIBOR as far back as 2005.   The Barclays settlement does not include potential civil litigation by investors and others that may occur as the result of the fraud. 

These 23 banks participate in the 10 currency panels that establish the LIBOR.  And, 18 of these banks submit rates for the U.S. dollar LIBOR (footnoted below).

Name Country Ticker No. of Panels Weiss Financial Strength Rating
Barclays, PLC4 United Kingdom BARC.LN
10
D-
Deutsche Bank AG4 Germany DBK.DE
10
D
HSBC4 United Kingdom HSBA.LN
10
C
Lloyds Banking Group4 United Kingdom LLOY.LN
10
E
JPMorgan Chase4 United States JPM
9
B
Royal Bank of Scotland4 United Kingdom RBS.LN
9
D-
Societe Generale4 France GLE.FP
6
D-
Bank of Tokyo-Mitsubishi UF4 Japan Mitsubishi (8306.JP)
5
C-
UBS AG4 Switzerland UBSN.VX
5
C-
Citigroup4 United States C
4
C
Royal Bank of Canada4 Canada RY.CN
4
C+
Credit Agricole4 France ACA.FP
3
E
Credit Suisse4 Switzerland CSGN.VX
3
C-
Mizuho Corporate Bank Japan Mizuho (8411.JP)
3
D+
Rabobank1, 4 United Kingdom Rabobank
3
U
BNP Paribas4 France BNP.FP
2
C-
Commonwealth Bank of Aus Australia CBA:AU
2
C+
Sumitomo Mitsui Bank4 Japan SMFG (8316.JP)
2
C-
The Norinchukin Bank2, 4 Netherlands N/A
2
U
Banco Santander3 Spain SAN.SM*
2
D-
Bank of America4 United States BAC
1
D+
Bank of Nova Scotia Canada BNS.CN
1
C
Canadian Imperial Bank of Comm Canada CM:CN
1
C

 

1 Privately held bank based in the Netherlands, operates in 48 countries including the U.S. 
2 Privately held agriculture cooperative bank based in Tokyo, Japan
3 Abbey National, PLC was acquired by Banco Santander, SA in July 2004
4
Banks that are on the U.S. Dollar LIBOR panel

While there has been no official mention of the banks suspected to be involved in the scandal or being investigated for possible wrong doing, it is clear Barclays did not act alone. So, other banks are likely to face regulatory scrutiny for similar price collusion and rate manipulation.  Looking at the table above, you can see the banks that might have more exposure based on the number of currency panels they sit on.  For example, Barclays (BARC.LN), Deutsche Bank (DBK.DE), HSBC (HSBA.LN) and Lloyds Banking Group (LLOY.LN) sit on all 10 currency panels and may have a higher risk of investigation and also a higher probability or incentive to manipulate the LIBOR rate.  

For those banks that may have the most exposure, let's look at the potential hit to earnings based on regulatory fines and potential civil litigation.  The earnings-per-share (EPS) hit could translate to a drop in stock price if the institution is implicated in the scandal. 

Name Ticker
No. of Panels
Projected 1 Fines
($mil)
Projected 2 Civil
($mil)
EPS Hit Fines + Civil
Barclays, PLC BARC.LN
10
D-
453
906
$0.11
Deutsche Bank AG DBK.DE
10
D
450
1,800
$2.42
HSBC HSBA.LN
10
C
450
1,800
$0.12
Lloyds Banking Group LLOY.LN
10
E
450
1,800
$0.03
JPMorgan Chase JPM
9
B
450
1,800
$0.55
Royal Bank of Scotland RBS.LN
9
D-
450
1,800
$0.37
Societe Generale GLE.FP
6
D-
270
1,080
$1.74
Bank of Toyko-Mitsubishi UF 8306.JP
5
C-
225
900
$0.08
UBS AG UBSN.VX
5
C-
225
900
$0.29
Citigroup C
4
C
180
720
$0.31
Royal Bank of Canada RY.CN
4
C+
180
720
$0.62
Credit Agricole ACA.FP
3
E
135
540
$0.27
Credit Suisse CSGN.VX
3
C-
135
540
$0.52
Mizuho Corporate Bank 8411.JP
3
D+
135
540
$0.03
Rabobank N/A
3
U
135
540
N/A

 

1 Projected fines are based on the Barclays $450 million fine (in U.S. dollars) and the number of panels individual banks are on.
2Projected civil litigation is based on the average of high and low estimates of 4x projected fines.

For banks with fewer shares outstanding, the impact of fines and civil litigation on earnings per share (EPS) might be more severe.  For example, Barclays, with more than 12.2 billion shares outstanding, would take an $0.11 per share hit on earnings (U.S. dollars) compared to the $2.42 per share hit on earnings for Deutsche Bank with only 929.5 million shares outstanding.

Bank
Ticker
No. of Panels
Stock Price July 20
Potential Low Stock Price
Further Potential  Decline from July 20 Stock Price (%)
Barclays, PLC BARC.LN
10
159.25
****
****
Deutsche Bank AG DBK.DE
10
24.75
22.92
-7.4%
HSBC HSBA.LN
10
533.20
464.13
-13.0%
Lloyds Banking Group LLOY.LN
10
29.94
25.24
-15.7%
JPMorgan Chase JPM
9
34.46
29.79
-13.5%
Royal Bank of Scotland RBS.LN
9
204.70
188.81
-7.8%
Societe Generale GLE.FP
6
16.39
13.84
-15.5%
Bank of Toyko-Mitsubishi UF 8306.JP
5
368.00
293.22
-20.3%
UBS AG UBSN.VX
5
10.03
8.95
-10.8%
Citigroup C
4
26.59
21.95
-17.4%
Royal Bank of Canada RY.CN
4
52.41
41.62
-20.6%
Credit Agricole ACA.FP
3
3.21
2.62
-18.5%
Credit Suisse CSGN.VX
3
16.83
13.88
-17.5%
Mizuho Corporate Bank 9411.JP
3
124.00
102.87
-17.0%
Rabobank N/A
3
N/A
N/A
N/A

 

Barclays incurred price depreciation in the vicinity of 19 percent since the scandal was announced on June 28.  If other banks are implicated, you may expect similar stock price depreciation for those institutions with the highest risk.  The table above estimates what the resulting lowest stock price would be after depreciating 19 percent from its June 28 price, then compares it to the closing price on July 20 to project how much further the price could fall on a percentage basis. 

There may be more damage from the fallout than from the rate manipulation itself.  Once again, we see that there is little backstop to keep banks from acting in their own self interest, often at the expense of their own clients.  The very foundation of our faith in the integrity of the financial system and regulatory oversight has been badly shaken — yet again.  And the financial impact of fines and penalties loom large for the banks and investors in the financial sector. 

This scandal, even if it remains primarily outside the United States and the Federal Reserve's control will undoubtedly produce a major overhaul in the process to calculate the LIBOR rate. While it may take some time to overhaul the process,  today's sophisticated technology should make it possible to calculate the LIBOR based on actual bank data from existing contracts  while tapping a broader base of banks to be in on the process then the 23 that are currently involved.  This should make it more difficult for banks to skew results going forward.  We also hope there have been many lessons learned by regulators that will translate to a more even playing field for banks, customers and investors.   

 

See also:
Why You Cannot Ignore the Rest of the World
Banks Suing Banks Over Libor
New Investigation Overshadows Barclays Financial Results
Capital One Settles Deceptive Marketing Allegation for $210 Million
Wells Fargo Settles Borrower Discrimination Charges for $175 Million
HSBC Could Face Billion Dollar Fine for Money Laundering

Gavin MagorGene Kirsch, senior banking analyst at Weiss Ratings, has more than 20 years of financial industry experience in credit-risk management, commercial lending and loan review analysis within various sized credit unions, finance companies and banks at both the retail and commercial level. He leads the firm's bank and thrift ratings division and developed the methodology for Weiss' credit union and global bank ratings.

Copyright © Weiss Ratings. All rights reserved. http://weissratings.com