SS51: Understanding the London Interbank Offered Rate (LIBOR)

SS51: Understanding the London Interbank Offered Rate (LIBOR)

Charles explains what LIBOR is and why it is important to real estate investors.

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Talking Points:

  • Libor rates are calculated for five currencies (US dollar, EURO, British pound, Japanese yen, and Swiss franc) and borrowing periods (maturities) ranging from overnight to one year and are published each business day by Thompson Reuters. Many financial institutions set their own rates relative to it.
  • At least $350 trillion in derivatives and other financial products are tied to Libor; credit cards, syndicated loans, student loans, individual variable mortgages, and the list goes on.
  • If you have a credit card, you probably already have a financial product that is tied to Libor; check your statement and you will see how they calculate your interest rate and usually, it will be LIBOR (1 month or 3 months) + margin OR prime rate + margin
  • The most popular Libor is the 3-month US dollar rate
  • What does that have to do with real estate? Typically, all variable real estate debt is based on LIBOR; while fixed debt is based on the 10-year treasury
  • In 2008, 60% of prime adjustable-rate mortgages and all subprime mortgages were indexed to Libor
  • The Libor was created in 1969 when a Greek banker who was arranging an $80 million syndicated loan for the Shah of Iran
  • LIBOR came into widespread use in the 1970s and 1980s and it is the average interest at which major banks around the world borrow from each other.
  • Libor is calculated daily when the British Bankers Association (BBA) asks major banks around the world how much they would charge other depository institutions for a short-term loan. The BBA takes out the lowest rate and the highest rate and then averages the remaining figures and publishes this rate.
  • In 2012, the LIBOR scandal was discovered which included several bankers at major institutions who were rigging the rate and it has been discovered that this started as far back as 2003.
  • In 2023, LIBOR is being phased out; according to the Federal Reserve and regulators in the UK, and will be replaced with the Secured Overnight Financing Rate (SOFR) but at this time; if you are borrowing variable adjustable debt; you will most likely have a rate that is tied to LIBOR.
  • SOFR is based on the prior activity of overnight US transactions while LIBOR is prospective

Transcript:

Charles:
Welcome to Strategy Saturday; I’m Charles Carillo and today we’re going to be discussing understanding the London interbank offered rate or LIBOR. LIBOR rates are calculated for five currencies, us dollar, the Euro, the British pound, the Japanese yen and the Swiss Frank and the borrowing periods or maturities range from overnight to one year. And they’re published each business day by Thompson Reuters. Now, many financial institutions set their own rates relative to limo. And currently at least 350 trillion in derivatives and other financial products are tied to LIBOR. And this includes credit cards, syndicated loans, student loans in variable mortgages, and the list goes on. Now, if you have a credit card, you probably already have a financial product that is tied to LIBOR. Check your statement and you’ll see how you, how they calculate your interest rate. And usually it’ll be li O one month or three month maturity plus their margin or they’ll utilize prime rate plus their margin.

Charles:
Now the most popular Lior is the three month us dollar rate. So what does this have to do with the real estate while typically all variable real estate debt is based off of Lior while fixed debt is based off of the 10 year treasury in 2008, 60% of prime adjustable rate mortgages in subprime mortgages were indexed to LIBOR. The Lior was created, uh, by a Greek banker in 1969 when he was arranging 80 million syndicated loan for the Shaw of Iran. And when I say syndicated, that means there’s a number of different lenders that were put together to make this loan possible. Now LIBOR came into widespread use in the 19 and seventies and the 1980s, and is the average interest at which major banks around the world borrow from each other. Now, LIBOR is calculated daily when the British banker’s association or the BBA ask major banks around the world, how much they would charge other depository in institutions for a short term loan.

Charles:
The B ABA takes out the lowest rate and the highest rate, and then averages the remaining figures and publishes this rate. Now in 2012, the LIBOR scandal was discovered, which included several bankers at major institutions who were rigging the rate. And it was, had been discovered. This started as far back as 2003. So in 2023, we’re told that Lior is being phased out according to the federal reserve and regulators in the UK, and will be replaced by the secured overnight financing rate or the S O FFR. But at this time, if you are borrowing a variable adjustable debt, you will most likely have a rate that’s tied to Lior. I know bridge debt and other loans we’re getting that are variable right now in real estate are tied to LIBOR. Usually you’ll see something like LIBOR plus, uh, two and a half or plus three as being the margin. And the O FFR is based on prior activity of overnight us transactions while the Lior is prospective. And what that means is that the Lior is easily manipulated. And that’s what happened to the scandal that was discovered in 2012 while the so FFR is something that’s done on actual prior activity of overnight us transactions, which means that’s a, it’s a lot harder to manipulate. So I hope you enjoyed, please remember to rate review, subscribe, submit comments, and potential show topics at global investors, podcast.com. Look forward to two more episodes next week. See you then

Announcer:
Nothing in this episode should be considered specific, personal or professional advice. Any investment opportunities mentioned on this podcast are limited to accredited investors. Any investments will only be made with proper disclosure, subscription documentation, and are subject to all applicable laws. Please consult an appropriate tax legal, real estate, financial or business professional for individualized advice. Opinions of guests are their own information is not guaranteed. All investment strategies have the potential for profit or loss. The host is operating on behalf of Syndication Superstar, LLC, exclusively.

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