Hospital and the Great Libor Conspiracy

HFA Partners  |  July 17, 2012

As the Libor scandal continues to unfold on both sides of the Atlantic, hospitals are wondering how they could be impacted, and what to do going forward. The answer may depend on the type of swap the hospital carried in the last few years.


In A Nutshell...

  • Large banks may have colluded to keep Libor rates artificially low in order to boost trading profits
  • Hospitals who received Libor under pay-fixed swaps would have been hurt by a lower-than-normal Libor rate
  • Hospitals who paid Libor on bank loans would have benefited from a low Libor
  • For the average hospital, losses are likely minimal and will be better known once the magnitude of the rate manipulation is determined.

Background

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 who 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 who 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.

Estimating Magnitude of Fixing

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% 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.



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 cash flows for the average hospital. However, 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.



Estimating The Impact of Libor Fixing On Swaps:


  • Impact on reduced Libor-based swap payments:
    Take your notional amount and multiply it by 1/100th of 0.7%. That’s the annual reduction in cash flows from a one basis point (1 bp) lower Libor rate, assuming a swap indexed at 70% of Libor.

  • Impact on swap termination values:
    Get the DV01 for the swap on the date it was terminated. DV01 is the $ impact on termination value of one basis point (1 bp) change in rates. If Libor was higher than reported, the termination value received would be greater (or, if negative, the termination payment would be smaller). If your swap counterparty is unavailable to provide DV01, send us your swap confirm and we’ll calculate it for you.

  • Example:
    Hospital had $50 million notional amount swap in place for the last 7 years, receiving 70% of the 1-Month Libor. Assuming Libor was reported 5 basis points lower than it should have during that time:
    - The hospital received $122,500 less than entitled to ($50,000,000 x 0.01% x 70% x 5 x 7 yrs = $122,500)
    - If DV01 was $50,000 on the date the swap was terminated, a 5 basis point lower than normal Libor cost the Hospital an extra $250,000 ($50,000 x 5) in termination payment. Note that we made some sweeping assumptions: no amortization, parallel shift in rates, etc.



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 who 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 accurately determine how the rate fixing may have impacted their financial performance.


This material is intended for general information purposes only and does not constitute legal advice. For legal issues, readers should consult legal counsel. To discuss this article or municipal advisory services, email info@hfapartners.com or call 888-699-4830. HFA Partners, LLC is an Independent Registered Municipal Advisor registered with the Securities and Exchange Commission (SEC) and the Municipal Securities Rulemaking Board (MSRB) under the Dodd-Frank Act of 2010.
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