Syndicated loans are, perhaps, the credit product most associated with LIBOR. Not only are virtually all loans set to a spread over LIBOR, but so are liabilities backing CLOs, the market’s essential funding source over the past decade.
Portfolio managers say Barclays’ recent admission that it attempted to manipulate the rate has led to an overwhelming amount of calls and e-mails from senior management, liability holders, and investors. The questions break down into four main categories. Here’s a rundown and some early views based on conversations with participants (though the comments are admittedly speculative):
Question 1: Were loan distributions and returns understated as a result of rate-fixing?
All of the reports so far suggest that during the crisis period of late 2008 and early 2009 – a time when just 8% of loans had a LIBOR floor, as opposed to 58% today – LIBOR was likely depressed. For how long and by how much remains unclear, however. More recently, participants say that the evidence is less than convincing. After all, since the scandal broke, three-month LIBOR has been little changed, at roughly 0.47%.
Question 2: If, indeed, LIBOR and, therefore, loan returns were artificially suppressed, will lawsuits be brought against the LIBOR banks in an attempt to seek restitution?
First, we live in a litigious age, and lawsuits within and outside the loan market are likely. Participants expect at least a few test cases from retail investors, CLO liability holders, and perhaps relative-value accounts. Of course, it remains unclear whether plaintiffs will be able to prove damages.
Question 3: At a more fundamental level, will the scandal chase investors from the market, dampening demand for loan mutual funds, CLO liabilities, and separate accounts?
Managers say they have seen no pushback from investors as a result of the LIBOR issue. And, in fact, rate-fixing was reported as early as 2008. But following Barclays’ June 27 admission of misconduct, flows into loan mutual funds have remained positive, at $357 million between June 28 and July 9, according to EPFR. Managers say they’ve seen no let-up in separate-account money. As for CLOs, the pace of issuance clearly has slowed in recent weeks, but managers say that is a result of narrowing arbitrage rather than the LIBOR issue.
Question 4: Will LIBOR give way to a price mechanism in the future that is less tied to subjective judgment?
“Possibly,” managers say, without much conviction one way or the other.
A final point: managers say that after the crisis LIBOR morphed into more of a central-banks-driven, Fed Funds-type measure rather than a market-driven level at which banks actually borrowed. The evidence, they say, is the mismatch between Overnight Index Swap rate and LIBOR, as an analysis from the Fed explains. – Steve Miller