Managing the Financial Side of Commercial Fleets

Does LIBOR Still Correlate to Corporate Borrowing?

Since the early 1990s, LIBOR has been used as a fleet lease funding index. However, recent financial market turmoil prompted governments to “backstop” bank borrowing, which caused LIBOR to no longer correlate to fleet lessor costs.

September 2009, by Mike Antich - Also by this author

LIBOR is a benchmark interest rate widely used as an index in trillions of dollars of lending and borrowing transactions around the globe. LIBOR, an acronym for London Interbank Offered Rate, is used to establish the cost of borrowing and lending to consumers, businesses, municipalities, and the capital markets.

LeasePlan was the first fleet management company to use LIBOR as a funding index for fleet leases, starting in the early 1990s. Until then, the fleet leasing industry used commercial paper as a funding index. Several years ago, other major fleet management companies also started using LIBOR-based funding as a primary index. One reason was that fleet management companies increasingly were receiving fleet RFPs asking for vehicle funding indexed to LIBOR.

"The lessee's own corporate debt was oftentimes based on a LIBOR, so it made it easy for them to compare their lease funding to their own funding," said Greg DePace, senior vice president of finance for Emkay.

Some lessees and lessors gravitated toward LIBOR as a funding index for other reasons.

"Historically, LIBOR has been a publicly available number that reasonably correlated with fleet leasing companies' cost of borrowing," said Dan Frank, vice president and general manager, Four Wheels at Wheels Inc. "Our customers found it useful in assessing different competitors in the marketplace, because it was a fairly consistent number that could be used as a benchmark."

Questions about LIBOR Accuracy

LIBOR was developed in 1984 to satisfy demands for an accurate measure of the real rate at which banks lend money to each other. LIBOR rates are published daily by the British Bankers Association for 10 major currencies and 15 maturities, ranging from overnight to one year.

LIBOR is a floating rate, calculated daily, based on the interest rates for unsecured funds banks lend to each other in 10 currencies in the London interbank market. The index is based on self-reported numbers submitted by 16 member banks as to their cost to borrow 30-day money. The index is not based on actual trades, but on what each member bank self-reports to the British Bankers Association.

However, a controversial article published in the May 28, 2008 edition of the Wall Street Journal (WSJ) questioned the accuracy of the LIBOR index. The article raised questions about several banks of the 16-bank panel that reports daily the rates used to calculate LIBOR in dollars.

Suspicions were voiced by other bankers that these rivals allegedly may have been low-balling their borrowing rates. These suspicions started in late January 2008 as fears grew about possible bank failures, and the concerns gained intensity with the collapse of Bear Stearns in mid-March.

Suspicions increased that some banks were allegedly understating their borrowing rates. The speculation was that if a bank submitted a much higher rate than its peers, it risked giving the appearance it was in financial trouble. As a result, the WSJ article reported, banks had an incentive to play it safe by allegedly reporting somewhat similar rates, which would cause reported rates to cluster.

After Lehman Brothers filed for Chapter 11 bankruptcy protection Sept. 15, 2008, the interbank lending market froze, affecting both LIBOR and the markets.

"While historically lessors could match-fund their book of business, now it was a significant risk that short-term liquidity may not readily be available," said Dave Dahm, chief operating officer and CFO for LeasePlan USA. "This may cause some to move away from the very popular LIBOR-indexed pricing into new benchmarks."

Also during fourth quarter 2008, concerns grew about the viability of many banks. As banks around the world began to be "stressed," critics speculated some banks allegedly began to under-report their cost of borrowing, not wanting to reveal that other banks would not lend to them or would lend to them only at higher rates.

"There was talk about changing the way banks report by using a trade rate versus a self-reported rate. LIBOR was starting to become a non-meaningful number," said Frank.

The end result was a tremendous amount of confusion in the fleet leasing market concerning not only LIBOR, but all indices used in floating rate leases.

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