The woes of a Libor bounce

If you are in my business, you know about Libor, which is an acronym for the London interbank offered rate. For those of you not familiar with it, Libor, is a benchmark for fixing loan rates around the world. It has increasingly been used in commercial real estate over the last few years over the old standard of US Treasuries. There are Libor "contracts" of varying lengths, such as 30, 90 and 180 days that we use as a benchmark interest rate. So, in other words, if I have a loan that is "6-month Libor + 225" that means the interest rate is 2.25% above the rate for a 180 day Libor contract at a given time (and then usually subject to adjustment each six months).

Now, in addition to the loan rate floors that I wrote about the other day, we have a new wrinkle: Libor rates are spiking the last few days, due in part, it seems, to possible "growing concerns among bankers that their rivals weren't reporting their true high borrowing costs, for fear of signaling to the market they were desperate for cash." What this means? Harder to get a decent loan rate, that's what, but that's also mainly due to the floors.

Before you jump off a cliff, remember that Libor a year ago was over 5%. Now it's gone up 20 bps in two days, but still around 2.9%. So don't panic.

In commercial real estate, the rise in Libor is bound to have a chilling effect, because many developers borrow heavily using floating-rate debt linked to Libor. Until recently, declining rates had benefited borrowers, but some lenders were growing wary. Banks have started to include a floor in Libor-linked loans, said Peter Fitzgerald, chief financial officer at Radco Cos., an Atlanta developer. That means borrowers' savings would be limited if Libor continued to sink, but borrowers can be hit by the latest rise.

"If Libor were at 4% instead of under 3%, there would be a disaster that would take years to unwind," he said.

If you have a big rate hike then I'd be worried because that could make a real mess out of some deals, as increased borrowing costs screw up your pro formas and blow your returns on deals. And should the markets consider going back to the old days of Treasuries if there is real concern about the integrity of the Libor system? Maybe. (As an aside, I also see opportunity for mezzanine lenders here.)