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The unprecedented overnight doubling in the interbank lending rate makes borrowing and refinancing sharply more expensive, for companies and consumers alike.
Alan Rappeport, CFO.com | US
September 17, 2008
As credit continues to tighten and investors flee to quality, the gap between the London Interbank Offered Rate (Libor) and U.S. Treasury three-month bill rates widened dangerously on Wednesday.
The TED spread — as the difference between those two measurements of borrowing costs is known — reached 236 basis points, more cavernous than at any point since the credit crisis began. It was, of course, a dramatic response to the failure of Lehman Brothers and the need for a federal rescue of insurance behemoth American International Group.
The Libor surge was most striking, with the overnight dollar rate more than doubling from 3.10625 percent to 6.4375 percent, a record jump. Three month dollar Libor increased from 2.816 percent to 2.876 percent. The rate, published by the British Bankers' Association, is determined by 16 banks reporting what they determine it would cost to borrow at different maturities and currencies. Meanwhile, three month Treasury bill rates fell 46 basis points to 0.23 percent, the lowest since 1954.
A high Libor — the rate that serves as a benchmark for interest rates on so many kinds of debt — has the potential to impact the entire U.S. economy. But specifically for companies, a spiking Libor can curtail profits and make it costly to refinance corporate loans. The Libor is the interest rate that banks charge to each other for short-term loans, and usually falls in line with the overnight federal funds rate managed by the Federal Reserve.
"The cost of borrowing is going to increase," says Rosa M. Abrantes-Metz, an economist at LEGC, a consultancy, and co-author of a recent paper on manipulation of Libor. "A lot of companies, especially in the financial sector, are already stressed at this point, and that could put additional stress on their costs."
Companies that are at risk of default, and looking to refinance loans, will find refinancing much more expensive and difficult. And the task will be especially tough for companies that are exposed to industries under the most economic pressure.
"Fees are very high to refinance a loan, so to the extent that the spiking Libor contributes to that proposition it's ominous," says Neil Schweitzer, a senior vice president in Moody's corporate finance group. "Would you like to be a CFO up against the headroom on your covenant right now?"
For Jerry Gronfein, CFO of Ben Bridge Jeweler, a 78-store retail chain owned by Berkshire Hathaway, Libor is a closely watched indicator because it is not only a basis for corporate borrowing rates but also for adjustable rate mortgages and other loans that affect customers.
"Libor is important because there are a lot of loans out there that are Libor-based for consumers," Gronfein tells CFO.com. "As a retailer in the quasi-luxury arena it affects us daily."
Additional debt servicing costs are particularly problematic for a firm's cash flow in a weak market, says Schweitzer. As debt servicing costs rise companies will look to avoid borrowing.
"We do have a small amount of our debt that is fixed, and Libor-based, and we'll see an increase. But it won't be material," says James Cline, CFO of Trex, a manufacturer of decking and fencing for homebuilders. "We can't change the Libor rate. All we can do is try to minimize our borrowing under it."
Kate Plourd contributed to this report