Investment View: Libor woes for banks could end up as a car crash

Judges will know successful claims could potentially bankrupt state-owned banks

It's likely that Royal Bank of Scotland will this week become the third bank to pay a substantial fine to settle charges that its traders tried to manipulate Libor interest rates. More will follow. The problem for the banks and for their investors is that dealing with the regulators is only the start of it.

Libor is used to price all sorts of financial contracts, from interest rate swaps to some mortgages. Anyone with a Libor-related contract, or one linked to one or more of its sisters, could have grounds to seek compensation if they can prove they were disadvantaged by the traders' shenanigans. Those people range from small borrowers, fighting on a no-win no-fee basis, to big hedge funds able to afford skilled and very expensive legal help.

It's a potential car crash, and has even been described as the banks' "tobacco moment". That's a reference to the string of lawsuits tobacco companies fought successfully, until the dam burst.

What should investors do? I talked to all four banks, as well as analysts, and lawyers. Let's start with the banks. None has yet made any provisions against the potential cost of Libor-related lawsuits. This is the response I got from Lloyds: "We have not taken any provision as it's just not possible at the moment to predict the scope and outcome of the various regulatory investigations or private lawsuits that are out there. That's both in terms of timing or scale."

RBS, Barclays, and HSBC are taking a broadly similar stance. Lloyds and HSBC may not be in it quite as deeply as RBS and Barclays.

How about the legal angle? Rich Eldridge, a finance partner at Manches, was kind enough to help. Here's what he had to say: "To be successful borrowers will have to show the basis on which they were led to believe Libor would be calculated was false and this was material. No one knows how likely the claims are to succeed, but judges will know successful claims could potentially bankrupt state-owned banks and hit pension funds."

So when it comes to provisions: "I doubt anyone knows the cost to the banks if the courts decide to award compensation for Libor fixing. Firstly, banks will need to repay customers who were overcharged. Secondly, judges may cancel interest rate swap contracts based on Libor and banks may be forced to compensate hedge funds who bought a bank's side of swap transactions. Investors in bank shares will no doubt be wary with no published figure of the potential exposure. A concern for a lot of people is bank shares can form a sizeable proportion of investments by pension funds."

In other words: this potential car crash could actually close off half the motorway.

How does the market feel about this? Ian Gordon is one of the more independent minded and thoughtful analysts. He says almost no one has this issue "front of mind".

"Two reasons for that. One, the market has increasingly convinced itself that the burden of proof is very high. So other than the potential for a "grand settlement" the potential for an individual bank suffering a multi-billion hit feels much lower now than it did perhaps in early July.

"And, two, my guess is that any such settlement won't hit until 2016/17 which removes any spectre of an unmanageable hit to capital. Just a potential hit to a (hopefully) more healthy income statement."

So not the end of the world. Who's likely to get hit? The received wisdom is Barclays and RBS, as a result of the attempts at manipulation by their traders (worth pointing out that it's yet to be proved how successful they were). But Mr Gordon has an interesting theory: "I can't help thinking that it was allegedly the [Libor] submissions of Lloyds [through HBoS] and RBS which were persistently low-balled over an extended period and by a material amount."

So his theory is the potential "tail risks may be longest for Lloyds and RBS? Just a theory".

Of course, the role of the Bank of England in the "low ball" submissions of Lloyds and RBS is somewhat murky. The central bank was desperately worried about the impact of a collapse in confidence in these two banks. But even if it was proved to have subtly endorsed the tactic you can't sue a central bank. If you want to grade the worries, RBS probably comes top followed by Barclays and Lloyds. HSBC shareholders may be able to breathe easier. Its sins were largely committed elsewhere.

As for valuations, they are still discounting difficulties for the banks. Even though Barclays shares have doubled since the summer it trades on only 0.6 times the book value of its businesses and a shade over 8.6 times earnings. As for Lloyds, it is on 0.8 times book, 12.7 times earnings, while RBS is on a remarkably similar valuation (0.8 times, 13.3 times). HSBC, by contrast, sits on 1.3 times book, and 11.5 times this year's earnings.

The only bank I've been recommending recently is Lloyds. Take profits. The banks' shares have been run up a lot and I'm taking a cautious view of the outlook.

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksAn introduction to the ground rules of British democracy
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
SPONSORED FEATURES
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Sales Adviser - OTE £24,500

£22500 - £24500 per annum: Recruitment Genius: Inbound and outbound calls with...

Recruitment Genius: Business Development Executive / Sales - OTE £40,000

£18000 - £40000 per annum: Recruitment Genius: This fast growing Insurance Bro...

Guru Careers: Research Associate / Asset Management Research Analyst

£40 - 45k (DOE) + Benefits: Guru Careers: A Research Associate / Research Anal...

The Green Recruitment Company: Graduate Energy Analyst

£20000 Per Annum: The Green Recruitment Company: Summary: The Green Recruitm...

Day In a Page

Turkey's conflict with Kurdish guerrillas in Iraq can benefit Isis in Syria

Turkey's conflict with Kurdish guerrillas in Iraq can benefit Isis in Syria

Turkish President Erdogan could benefit politically from the targeting of the PKK, says Patrick Cockburn
Yvette Cooper: Our choice is years of Tory rule under Jeremy Corbyn or a return to a Labour government

Our choice is years of Tory rule under Corbyn or a return to a Labour government

Yvette Cooper urged Labour members to 'get serious' about the next general election rather than become 'a protest movement'
Singapore's domestic workers routinely exploited and often abused in the service of rich nationals

Singapore's hidden secret of domestic worker abuse

David Cameron was shown the country's shiniest veneer on his tour. What he didn't see was the army of foreign women who are routinely exploited and often abused in the service of rich nationals
Showdown by Shirley Jackson: A previously unpublished short story from the queen of American Gothic

Showdown, by Shirley Jackson

A previously unpublished short story from the queen of American Gothic
10 best DSLRs

Be sharp! 10 best DSLRs

Up your photography game with a versatile, powerful machine
Solved after 200 years: the mysterious deaths of 3,000 soldiers from Napoleon's army

Solved after 200 years

The mysterious deaths of 3,000 soldiers from Napoleon's army
Every regional power has betrayed the Kurds so Turkish bombing is no surprise

Robert Fisk on the Turkey conflict

Every regional power has betrayed the Kurds so Turkish bombing is no surprise
Investigation into wreck of unidentified submarine found off the coast of Sweden

Sunken sub

Investigation underway into wreck of an unidentified submarine found off the coast of Sweden
Instagram and Facebook have 'totally changed' the way people buy clothes

Age of the selfie

Instagram and Facebook have 'totally changed' the way people buy clothes
Not so square: How BBC's Bloomsbury saga is sexing up the period drama

Not so square

How Virginia Woolf saga is sexing up the BBC period drama
Rio Olympics 2016: The seven teenagers still carrying a torch for our Games hopes

Still carrying the torch

The seven teenagers given our Olympic hopes
The West likes to think that 'civilisation' will defeat Isis, but history suggests otherwise

The West likes to think that 'civilisation' will defeat Isis...

...but history suggests otherwise
The bald truth: How one author's thinning hair made him a Wayne Rooney sympathiser

The bald truth

How thinning hair made me a Wayne Rooney sympathiser
Froome wins second Tour de France after triumphant ride into Paris with Team Sky

Tour de France 2015

Froome rides into Paris to win historic second Tour
Fifteen years ago, Concorde crashed, and a dream died. Today, the desire to travel faster than the speed of sound is growing once again

A new beginning for supersonic flight?

Concorde's successors are in the works 15 years on from the Paris crash