Lowest Libor Hides ‘Exceptionally Wide’ Bank Spreads
By Gavin Finch and Anna Rascouet
May 26 (Bloomberg) -- The drop in the London interbank offered rate, the benchmark for $360 trillion of financial products, to a record low masks a growing gap between the rates that the biggest banks charge each other for credit.
The difference between the highest and lowest interest rates banks say they pay for three-month dollar-denominated loans is near the widest this year, according to data compiled by the British Bankers’ Association. The spread signals that lenders still lack confidence in each other, even though measures ranging from the so-called Libor-OIS spread to corporate bond sales show credit markets have recovered from the freeze caused by the Sept. 15 collapse of Lehman Brothers Holdings Inc.
“It’s premature to judge that the credit meltdown is fully over,” said Kazuto Uchida, chief economist in Tokyo at Bank of Tokyo Mitsubishi UFJ Ltd., a unit of Japan’s largest bank. “Banks remain wary of extending credit to each other due to strenuous concerns about counterparty risk.”
Libor, a benchmark rate for everything from mortgages to company borrowing costs, fell to 0.66 percent, from 4.82 percent on Oct. 10. At the same time, the gap between the highest and lowest accepted quotes reported by the 16 banks that contribute to the London-based BBA for its calculation of Libor has averaged 7.5 basis points in May, according to Citigroup Inc. That’s up from 4.9 basis points in April and 1.5 basis points in the six months before Lehman’s bankruptcy. It widened to 9 basis points on May 14, the most since Dec. 3.
‘Exceptionally Wide’
While the spread, calculated by discarding the highest and lowest four quotes before determining the mean of the remaining eight, equates to about $76,000 of interest on a $100 million loan, it represents a growing proportion of Libor as the rate declines. On every day but 11 in the past three months, London- based Royal Bank of Scotland Group Plc, which is under government control, submitted the highest rate in the daily survey, according to data compiled by Bloomberg.
“The dispersion of Libor submissions seems to be exceptionally wide,” said Marc Chandler, the global head of currency strategy at Brown Brothers Harriman & Co. in New York. “There is potential for bifurcation of the financial system between banks perceived to be healthier than others.”
Royal Bank of Canada, Norinchukin Bank, Royal Bank of Scotland and Bank of Tokyo-Mitsubishi UFJ Ltd. quoted rates higher than today’s Libor. JPMorgan Chase & Co, Citigroup, Deutsche Bank AG and HSBC Holdings Plc posted rates below.
Lehman’s Collapse
Lending between banks started to freeze in August 2007, when losses linked to the collapse of U.S. subprime mortgages left financial institutions with billions of dollars in securities and financial contracts they couldn’t value. Losses and writedowns at the world’s biggest financial companies since the start of 2007 have grown to $1.47 trillion.
Concern about the deteriorating health of financial markets peaked in September when Lehman collapsed, Merrill Lynch & Co. was sold to Bank of America Corp. and American International Group Inc. was bailed out by the government.
Yields on Treasuries fell to record lows in 2008 as investors fled corporate bonds and stocks for the safety of government debt. Libor rose even as central banks around the world slashed interest rates, jumping from 2.82 percent in the days before Lehman’s bankruptcy.
Federal Reserve Chairman Ben S. Bernanke warned in congressional testimony on May 5 that another shock to the financial system would undercut the central bank’s forecast that the recession will give way this year to a recovery.
There are signs that the more than $12.8 trillion the U.S. government and Fed agreed to lend, spend or commit has loosened credit.
Credit Thaw
U.S. companies have sold a record $600 billion of bonds so far this year, up from about $500 billion in the same period of 2007, according to data compiled by Bloomberg. Rates on 30-year fixed mortgages are about 1.8 percentage points more than 10- year Treasuries, down from 3.27 percentage points in December. Morgan Stanley’s MSCI World Index of stocks is up almost 38 percent from its low this year in March.
While financial markets are improving, more than 60 U.S. financial institutions have collapsed over the past two years, according to Bloomberg data. In its latest quarterly survey of senior loan officers, the Fed found that more than 70 percent of respondents said bad loans will rise should the economy progress “in line with consensus forecasts.”
The world economy is projected to shrink 1.3 percent this year, the International Monetary Fund said in April, reversing a previous forecast of 0.5 percent growth.
Libor-OIS Spread
Libor-OIS, which indicates banks’ reluctance to lend, fell to 0.45 percentage point today, the lowest level since February 2008. Still, futures indicate the measure is about two years away from shrinking to 0.25 percentage point. That’s the level former Fed Chairman Alan Greenspan has said would be considered “normal.”
“The historic level for the years immediately preceding the crisis for the Libor-OIS spread was about 10 basis points,” Greenspan said in a May 22 interview. “It seems quite unlikely that we will get the general tightness of spreads that existed back then as it implied a degree of under-pricing of risk that was not sustainable. If we get to 25 basis points or below and keep it there, these markets will start to ease up.”
The BBA asks member banks each morning how much it would cost them to borrow from each other for 15 different periods, from overnight to one year, in currencies from dollars to euros and yen. It then calculates averages, throwing out the four highest and lowest quotes, and publishes them after 11:30 a.m. in London.
Growing Differences
Libor would have been 0.67437 percent today when including the four highest and lowest quotes, above the 0.66 percent reported rate. London-based HSBC reported the lowest rate, at 0.60 percent, and Royal Bank of Canada in Toronto the highest, at 0.86 percent.
The difference of 26 basis points was down from a gap of 35 basis points on May 22, the most since Jan. 9. The disparity averaged almost 58 basis points in the fourth quarter, according to John Ewan, a director of the BBA. Royal Bank of Scotland, or RBS, quoted the highest rate about 85 percent of the time since Feb. 19, according to the BBA.
JPMorgan, which has applied to repay the funds it borrowed from the U.S. Treasury Department under the $700 billion financial rescue package, typically quoted the lowest, BBA data show.
Spokespeople at RBC, RBS and JPMorgan either declined to comment or didn’t immediately return calls for comment.
Holding On
“The disparity and the difference is really a signal to the market of who really wants to make some loans and who’s got the ability to make those loans,” said Mark MacQueen, partner and money manager at Austin, Texas-based Sage Advisory Services Ltd., which oversees $7.5 billion. “A lot of banks are just trying to hold on to what they have and not really make loans.”
Rather than signaling that the world’s banks are more willing to lend to each other, some investors and strategists say the decline in Libor has more to do with deposits reducing demand for funds in the interbank market. Deposits at U.S. banks jumped by almost $400 billion in the past six months, according to Jim Vogel, head of bond research at Memphis, Tennessee-based FTN Financial.
“Libor’s decline is not necessarily a sign of improving bank credit or the willingness of banks to lend to each other,” said Vogel, whose firm is one of the 10 biggest underwriters of Fannie Mae, Freddie Mac and other U.S. government agency debt. “It’s a sign of improving bank liquidity as customer deposit growth replaces borrowing in the short-term money markets.”
Under Fire
Libor came under fire last year amid concern that some banks were underestimating borrowing costs to avoid the perception they were in financial straits.
Former Bank of England policy Willem Buiter described Libor last year as the “rate at which banks don’t lend to one another.” Libor “is just cheap talk,” said Buiter, who is now a professor at the London School of Economics.
The BBA has rejected those concerns, saying the rates are an accurate representation of interbank lending rates. “Dollar Libors are coming down, which implies all banks are able to fund more cheaply,” Brian Mairs, a spokesman at the British Bankers’ Association, said in an e-mail.
While borrowing costs have tumbled, banks must still raise “large” amounts of money, Greenspan said in a separate interview last week. The comments came a day after Treasury Secretary Timothy Geithner told lawmakers that banks had issued more than $56 billion in new stock or debt since stress tests by regulators on the 19 biggest U.S. lenders found that 10 firms needed to raise about $75 billion.
“There is still a very large unfunded capital requirement in the commercial banking system in the United States and that’s got to be funded,” Greenspan said.
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