Just as we noted here [10], the analyst estimates for the potential impact of Libor (litigation and regulatory) liabilities have begun. Morgan Stanley sees up to a 17% hit to 2012 EPS (from $420 to $847 million per bank) in a worst case from just regulatory costs, and a further 6.8% potential hit to 2013 EPS if the top-down $400 million average per banks losses from litigation are taken on one year (considerably more if the bottom-up numbers of more than $1 billion are included). They see LIBOR risk in three parts: regulatory fines (we est median 7-12% hit to ‘12 EPS; litigation risk (7% EPS hit over 2 yrs); and less certainty on forward earnings. There are a plethora of assumptions - as one would expect - but the ranges of potential regulatory fine and litigation risk are very large though the MS analysts make the greater point that the LIBOR 'fixing' broadens investor support for more transparency in fixed income trading in addition to fixed income clearing leaving the threat of thinner margins as another investor concern.
We estimate LIBOR regulatory fines off of Barclays settlement. Our bull case: a 2-9% hit to 2012e EPS as banks settle with regulators for the same amount as Barclays. Our base case: a 4-13% hit to 2012e EPS as, apart from UBS, banks do not receive the discount that Barclays got for being early and cooperative. Our bear case, 5-17% hit to 2012e EPS: a 30% premium to base case fines to reflect the possibility that the UK Serious Fraud Office layers on new fines once its LIBOR investigation (started July 6) is completed.
[11]
LIBOR litigation risk is harder to quantify, but we take a stab. We assume every 1bp of LIBOR understatement every day for 4 years represents a $6 billion hit to the LIBOR panel of banks. If the 16 banks listed in the class action lawsuits shared equally, we estimate this would be a ~$400 million hit per bank.
Top-down:
[12]
We use a bottoms-up approach to assess impact on our EPS estimates that is proportional to each bank’s derivative book; we estimate the hit would range from $60 million to $1.1 billion. See page 4 inside for our long list of assumptions in arriving at this estimate. We run both estimated LIBOR fines and litigation charges through our US LC Bank EPS estimates.
Bottom-Up (1 Year EPS Impact):
[13]
Bottom-Up (2 Year Total Litigation expectations):
[14]
LIBOR setting changes, debate over industry structure and investor demands for more trade transparency all reduce certainty on forward estimates. Changing LIBOR could shift market share or drive one-off valuation adjustments. Renewed debate in the UK on Vickers/banking separation could resonate elsewhere. More trade transparency could thin margins and shift share further to efficient participants.
Additionally, the LIBOR fixing broadens investor support for more transparency in fixed income trading in addition to fixed income clearing. The threat of thinner margins is another investor concern. Counterparties with the most transparent trading and clearing platforms ultimately win, speaks to a need for strong electronic trading backbone in FICC, as well as size/scale.
So the big get bigger once again...
Source: Morgan Stanley