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Commentary

LIBOR is up to 6.45%

It seems the subprime issues have started to affect LIBOR quite a bit. From the Telegraph:

Morgan Stanley said that the recent jump in the benchmark London Interbank Offered Rate, which yesterday rose to just under 6.45pc, was not merely a seasonal blip but a major warning sign of pain ahead.

It came amid further jitters in the banking sector, where many smaller, more indebted banks are struggling to find lenders to keep them afloat.

Libor rates, which indicate how willing banks are to lend to each other, have risen sharply during the past week, after spending almost two months close to the 6.3pc level – a worrying sign since it was Libor’s increase in August that signalled the initial impact of the credit crunch.

Uhm, weren’t a lot of Indian ECBs linked to LIBOR? Last I heard, LIBOR was around 5% or so. If we consider that most Indian ECB Loans are linked to LIBOR and that most were made earlier this year or last, when the LIBOR was about 5.3%, then there is an interesting problem. From RBI, As of March 31, 2007, nearly 72,000 cr. was in ECBs, and between April and June, a further Rs. 34,000 cr. was added. This is a net of Rs. 106,000 cr., which we can consider at a dollar rate of 42 or so, meaning they $25.2 billion. LIBOR on this has gone up 1%, which is an additional interest of $250 million dollars a year, or Rs. 1000 crores. Of course one might imagine that the dollar has reduced in value – but remember that the reduction has already been accounted for as “foreign exchange gains”.

So who’s affected? I don’t know, but let me try and guess. Tata Steel for instance has a big loan for Corus, syndicated AFTER Jun 2007. This involves three tranches adding up to a total of 3.7 billion pounds. The effective rate is around LIBOR plus 200 points. For that loan, Tata Corus will end up paying an additional interest next year (if LIBOR stays this way) of about 1% higher – effectively around $80 million, or Rs. 300 cr. This is about 10% of Tata Steel’s Net Profits annualized. (Of course if the pound goes down against the rupee further some of the losses may be recovered, but I doubt it will impact it as much as 300 cr.)

Who else? ICICI Bank seems to have a ton of them, according to this article. It has raised about $12.5 billion in the last two years, and these loans are all linked to LIBOR it seems. If LIBOR goes up 1%, their net payment is up about $125 million which is about 500 cr. That’s again about 10% of profits.

Now I don’t have all the information about how the ECBs are structured but on the face of it the LIBOR rise will affect every single ECB given. Companies like Reliance Industries, Reliance Communications, L&T, Bharti Airtel etc. have also got a lot of ECBs – the only company that will not show a serious loss is Reliance Industries as they have not booked forex gains for the gains in the dollar so far.

Given that with the subprime crisis the LIBOR may stay at this rate or go higher, and the impact may be quite heavy to some Indian companies. But some questions I have are:

  • Am I being too simplistic? Is this a valid concern at all?
  • Is there something called a fixed rate loan? Or if the loans say LIBOR+something they reset every x months as LIBOR changes?
  • Do you know a list of Indian companies with their ECBs, amounts and rates?

Will be interesting to probe this further.

Disclosure: Short Nifty.

  • Hari Swaminathan says:

    >Deepak – I was going to send you a link on the LIBOR situation – This is really worrisome. Believe it or not, most home mortgages in the US which are of the “floating” type are actually pegged to LIBOR. So, in some sense, LIBOR going up will only exacerbate the already degenerated mortgage situation.

    As for the big companies exposure like Tata Steel and ICICI Bank, I don’t think they will have too much of a hit. They would probably have hedged their loan situation with interest-rate swaps or similar hedging instruments. These companies are well aware of the impact that interest rates can have on their financials, and just like IT majors would have hedged against currency changes, these companies should have taken care of interest rate fluctuations.

    But an alarming development indeed !!
    hari

  • Deepak Shenoy says:

    >I hope they have, Hari. We’ll have to wait and see I guess, and check thatif these loans haven’t yet been closed or the swaps weren’t written alongside.

    If they’ve hedged the same way IT majors have done for currency (1 quarter of hedges for Infy for instance) then we’re in for some major damage.

    I didn’t know US home mortgages were linked to LIBOR! My goodness, doesn’t that magnify the default rate on reset!

  • Anonymous says:

    >Deepak, LIBOR is of different flavors based on the currency of lending between banks and the timeperiod. EUR/USD/GBP, and overnight/3-mnth/6-mnth/1-yr.

    6.45 that you mention should be the Sterling 3-month rate and not USD (Bank Of Eng. overnight rates are at 5.75 and penalty overnight rate is 6.75%). Overnight LIBOR should closely track the BoE overnight rate since BoE has a mandate to preserve 5.75% general overnight rate. But BoE doesnt intervene for anything other than overnight rates. And for overnight rates too, it will intervene only if the general overnight rates exceeds 5.75, and not the rate for a particular bank.

    Since B0E is very hawkish, UK banks would rather not borrow from B0E overnight even if 3-month LIBOR gets above 6.75, to avoid a Northern Rock situation.

    FED rates are at 4.5% and penalty at 5%. But USD LIBOR shouldn’t go above 5%. Since the FED encourages discount lending, banks will prefer to borrow from FED rather than each other if USD. This is unlike the BoE situation.

    Also, if I am not wrong, most “exotic” US mortgages are indexed to 6-month USD LIBOR lending rates.

  • Anonymous says:

    >Deepak, the LIBOR rate you have mentioned probably relates to GBP (pounds sterling) for a 3 month period. I think most of the Indian companies have borrowed in USD and not in GBP may be, except for Tata Steel.
    The ongoing LIBOR for USD for 6 months time period is 4.85. With FED continuing to reduce the interest rates, I believe USD Libor cant be high as 6.5%. But the point you are trying to make is very valid with the global liquidity crisis due to sub-prime. regards,
    Venkat Muthukrishnan
    http://www.venkateswaran75.blogspot.com