With the admission by Barclays Bank that it manipulated LIBOR rates for its financial advantage, and the suggestion that other large global financial institutions may have done the same, healthcare borrowers whose loans or other financial products are based on LIBOR are considering whether they have been adversely affected. For many healthcare institutions that have paired tax-exempt bonds with LIBOR-based swaps, there is a real possibility that the swap payments they received were lower than they should have been because Barclays and other banks may have intentionally understated LIBOR to make their financial strength during the banking crisis in 2008-2009 appear better than it was.

In the typical tax-exempt bond issue paired with an interest rate swap, the bonds (usually credit-enhanced by a letter of credit) have their interest rates reset frequently – either daily or weekly – based on the Securities Industry and Financial Markets Association (“SIFMA”) index, an index based on rates applicable to certain tax-exempt bonds. Although borrowers have had the ability to use swaps in which they are paid based on the SIFMA index, those swaps required a higher fixed rate payment because the tax risk associated with LIBOR-based swaps was eliminated. ¹ Because 67% of LIBOR historically has been a proxy for the SIFMA index, many borrowers chose to enter into LIBOR-based swaps because they would result in a lower fixed rate payment to the swap counterparty.

While there is much to be learned about the market manipulation by Barclays and any other banks that undertook similar actions, it is clear from the materials released relating to Barclays that it occasionally overstated LIBOR because of some perceived trading advantage. Although that appears to be the exception to the general pattern of understatement, it indicates that a determination of how a healthcare borrower with a tax-exempt bond issue paired with a LIBOR-based swap was affected will not be easy to calculate. Nor is it clear whether a healthcare borrower with a swap with a bank that was not part of the LIBOR rate-setting process (or that did not manipulate rates) will have any right to recover any losses it may have suffered.

Investigations by at least five state attorneys general are underway, as are hearings at the United States Congress. In addition, at least one major action has been filed in federal district court in New York by a number of plaintiffs, including the City of Baltimore, seeking damages relating to LIBOR-based swaps. Where the investigations, hearings and litigation will lead is unclear, but the reaction is reminiscent of what occurred when the auction rate securities market collapsed in 2008.²

We believe that our healthcare clients with tax-exempt bonds and LIBOR-based swaps should carefully monitor developments in the coming weeks and months. It may be that some form of global relief, as was the case with the auction rate securities issues, becomes available. If not, then these borrowers will need to decide whether and when to bring litigation of their own to address any losses they may have suffered.³

¹The SIFMA index, based on rates for certain tax-exempt bonds, reflects tax-exempt interest rates. If marginal tax rates change, or if bonds lose their tax-exempt status, the amount paid by a borrower on its bonds will increase to the equivalent of a taxable rate. LIBOR is a taxable rate. By entering into a swap based on the historical tax-exempt equivalent of the SIFMA rate (typically 67% of LIBOR), the borrower assumes the risk that the 67% of LIBOR payment will be less than the rate on the bonds if tax rates change or the bonds become taxable. A borrower with a SIFMA swap does not assume the same tax risk if income tax rates change: any rise in the SIFMA rate reflecting such changes would be reflected in the swap payments from the counterparty.

²Following the auction rate securities collapse, major financial institutions entered into settlements at the federal and state level which made their customers whole to varying degrees. In that case, the financial institutions had held investments in auction rates securities out as “cash equivalents”, which they were not as they depended on market participants (i.e., willing buyers) to create liquidity. When the major market makers stopped purchasing these securities in February 2008, the entire market collapsed and continues to be illiquid 4 ½ years later.

³Many borrowers who had letter of credit-backed bonds with related LIBOR-based swaps have terminated their letters of credit and opted for direct purchases, often with the bank that had provided the letter of credit. Most tax-exempt direct purchases are based on a percentage of LIBOR plus a spread. In that case, although there might be some continuing losses if the percentage of LIBOR on the direct purchase is not the same as the percentage of LIBOR on the swap, the likelihood of any substantial continuing losses has been terminated because of the consistency between the loan and swap bases.