Some more big scary Libor risk numbers to digest | FT Alphaville

Some more big scary Libor risk numbers to digest

It’s been a little while since we had a nice Libor risk estimate so we were delighted when Morgan Stanley’s attempt dropped into our inbox. MS take the Libor risk in three chunks:

1) Regulatory fines (an estimated median 7 to 12 per cent hit to 2012 EPS). From MS (all with our emphasis):

We estimate LIBOR regulatory fines off of Barclays settlement. Our bull case: a 2-9% hit to 2012e EPS as banks settle with regulators for the same amount as Barclays. Our base case: a 4-13% hit to 2012e EPS as, apart from UBS, banks do not receive the discount that Barclays got for being early and cooperative. Our bear case, 5-17% hit to 2012e EPS: a 30% premium to base case fines to reflect the possibility that the UK Serious Fraud Office layers on new fines once its LIBOR investigation (started July 6) is completed.

We assume banks pay a premium to Barclays settlement {of $455.8]. Barclays’ settlement included a 30% discount from the FSA because the firm was early and cooperative with regulators… If we gross-up Barclays’ settlement for the 30% discount from the FSA and assume an implicit 30% discount from the DOJ/CFTC, we calculate an implied base penalty of $650 million (i.e., equivalent to a 43% premium to the $450 million Barclays paid).

2) Litigation risk (an estimated 7 per cent EPS hit over two years):

LIBOR litigation risk is harder to quantify, but we take a stab. We assume every 1bp of LIBOR understatement every day for 4 years represents a $6 billion hit to the LIBOR panel of banks. If the 16 banks listed in the class action lawsuits shared equally, we estimate this would be a ~$400 million hit per bank. We use a bottoms-up approach to assess impact on our EPS estimates that is proportional to each bank’s derivative book; we estimate the hit would range from $60 million to $1.1 billion.

MS assumes that banks won’t sue each other, that 50 per cent of investors were adversely impacted and that the duration of the Libor suppression was four years, from 2007-2011 (based on the dates of Schwab litigation claims).

Top-down industry approach suggests $6b of potential industry risk ($0.4b per company) per one basis point of LIBOR suppression (assuming LIBOR suppressed daily over a 4-yearperiod). This equates to $0.4b per company for every 1bp of LIBOR suppression, if we divide the industry estimate by 16 companies potentially implicated (there were 16 banks listed inthe class-action lawsuits). Our starting point is industry-wide notional outstanding that is linked to LIBOR.

Bottom-up company approach suggests potential risk varies from $60m to $1.1b. At the high end are companies with relatively larger rate derivative books. Impact to book value ranges from 0.1% to 1.3%. Our starting point is each bank’s rate derivative book as rate derivatives are linked to LIBOR.

Probability of mounting a successful claim against the banks: we estimate this at 36%. We look to a PWC securities litigation study which shows that of the financial crisis lawsuits completed to date, 36% settled and 64% were dismissed.

So they get this for the top-down estimate:

Or, in the bottom-up case:

(Before anyone raises objections, it should be noted that MS caveat this analysis heavily and are aware of its ‘finger in air’ quality.)

And finally, with even smaller chance of a reliable figure being produced:

3) Less certainty on forward earnings as regulators/politicians demand Libor changes and renew debate on industry structure while investors demand more trade transparency:

LIBOR setting changes, debate over industry structure and investor demands for more tradetransparency all reduce certainty on forward estimates. Changing LIBOR could shift market shareor drive one-off valuation adjustments. Renewed debate in the UK on Vickers/banking separation couldresonate elsewhere. More trade transparency could thin margins and shift share further to efficient participants.

The full note (with more granular detail on specific banks and ongoing actions alongside plenty of caveats) is in the usual place.

Related links:
Almost everyone goes mental about Libor – FT Alphaville
Counting the costs of (potential) Libor litigation – FT Alphaville
In defence of Libor quote-rigging, encore – FT Alphaville
Libor manipulation and the invisible whistle – FT Alphaville