RLPC-Loan pricing to jump as banks plan LIBOR alternative

By Tessa Walsh

LONDON, April 22 (Reuters) - Loan syndicators are close to implementing alternatives to screen-based Libor rates, a move that could herald a sharp jump in the cost of borrowing as banks try to pass their increased funding costs on to clients, senior bankers said on Tuesday.

"We are days away from getting a reference bank based loan past the borrower to introduce to the market," said Julian van Kan, head of loan syndication at BNP Paribas.

The move could be the European loan market's biggest structural shift in a decade if widely adopted, as all syndicated loan documentation is currently based on screen-based Libor rates.

Changing the reference rate could herald a faster rise in the cost of borrowing for all companies; potentially putting a brake on lending and ultimately curbing economic growth as Europe braces for a possible recession.

Bankers say that Libor is no longer an accurate reflection of individual banks' funding costs, due to widespread distrust and illiquidity in the interbank market, bankers said.

"We need to adjust the reference rate itself, get rid of screen-based Libor -- at least in this period of inflection -- and get loan documentation set on the reference bank rate," said van Kan, who also heads the loan managers forum in London.

The reference bank rate setting mechanism is the traditional method of calculating Libor rates. It is calculated by averaging the funding costs of 3-5 banks in each loan syndicate.

HIDDEN PROBLEM

The rise in Libor rates quietly choked off syndicated lending in the first quarter as loan pricing, particularly in the relationship-oriented investment-grade market, failed to keep up with spiralling bank funding costs.

Most banks used to fund at sub-Libor rates, but escalating bank funding costs of 50-125 basis points (bps) or more have been eating into loan returns. In recent months it has been costing many banks more to lend than the 55-75 bps they were receiving on investment-grade loan interest margins.

The loan market also saw spikes in costs as large loans were given to borrowers due to thin supply in the illiquid interbank market, particularly in expensive dollar and sterling Libor.

Banks were unwilling to approach borrowers under increased cost of funds documentation which focusses on regulatory costs rather than funding costs. Change of circumstances documentation relating to market disruption also failed to gain critical mass as banks were unwilling to publicise higher funding costs.

"This was increasingly a problem in the first quarter, more so than risk-weighted assets and capital adequacy. Not many banks would say that their cost of funds had gone through the roof, they were trying to keep it quiet," a syndicate head said.

Most banks adjusted their internal Risk Adjusted Return on Capital (RAROC) models higher to accomodate increased funding costs but this did not solve the mismatch between fixed loan margins and floating rate LIBOR movement, bankers said.

SYNDICATION BREAKDOWN

The loan syndication process began to break down in Europe in the first quarter as few loans met the higher return requirements of revised internal models and banks declined to participate in thinly-priced corporate loans or reduce their commitments.

Arranging banks were left overexposed on loans such as Imperial Tobacco's (IMT.L) 9.2 billion pound loan backing its acquisition of Altadis. This dragged secondary prices lower to 96.50 as banks sold paper at a substantial loss to reduce exposure and free up capital. "We are sitting on underwriting positions and the message we are getting is that banks' costs of funds are too high. We want to see a proper cost of funds application to encourage lenders back into the market," a syndicate head said.

The move is expected to be unpopular with borrowers, who may however be forced to accept higher loan pricing to produce successful syndications and avoid more expensive bond issues.

Raising loan pricing will also keep capital flowing to areas that are heavily dependent on dollar borrowing and have been hit hard by the increase in smaller regional bank funding costs, such as bank borrowing in the Middle East, Turkey, Russia and CIS and Baltic States.

(Reporting by Tessa Walsh; editing by Elaine Hardcastle)