The London Interbank Offered Rate (LIBOR) has started fading into the sunset, and as a result new reference rates are emerging. LIBOR’s departure is a big change for banks and their corporate clients, which is why we’re providing details on the process as it unfolds.
Borrowers and lenders alike have been anticipating clarity regarding the end of LIBOR since 2017, when the Financial Conduct Authority (FCA), the United Kingdom regulator of the ICE Benchmark Administrator (IBA), first announced the IBA would cease publishing LIBOR in the upcoming years. The wait came to an end on March 5, 2021, when the FCA announced the final publication dates of December 31, 2021, for 1-week and 2-month U.S. dollar LIBOR and June 30, 2023, for all remaining U.S. dollar LIBOR settings. In addition, banks are focused on regulatory guidance to cease entering into new LIBOR contracts as soon as practicable but no later than December 31, 2021.
One of the leading candidates to replace LIBOR in the United States is the Secured Overnight Financing Rate (SOFR). At Truist we offer SOFR as an alternative rate for commercial loans and hedges such as interest rate swaps, so it’s important to understand some of SOFR’s features and how it compares to LIBOR.
SOFR gaining momentum
SOFR is gaining momentum as an alternative to LIBOR. The Alternative Reference Rates Committee (ARRC), a body convened by the New York Federal Reserve for the purpose of providing recommendations on the transition away from LIBOR and alternative rates, recommends SOFR as the replacement benchmark for LIBOR. In the summer of 2020, more than 70% of banks surveyed by Automated Financial Systems (AFS), a lending and risk management solutions provider to banks, reported plans to replace LIBOR with SOFR.Footnote a
Based on a more recent survey, in January 2021 AFS reported that one-third of bank respondents had already entered into new loan agreements with a SOFR rate and more than half were using SOFR rates to hedge their loans.Footnote b
SOFR is a broad measure of the cost of collateralized, overnight borrowing published on business days by the New York Fed. It has several characteristics that make it a viable alternative to LIBOR:
- SOFR is a secured rate based on an active underlying market with a diverse set of borrowers and lenders and is based on a daily volume of about $1 trillion in underlying U.S. Treasury repurchase transactions. This dwarfs the transaction volumes currently underlying LIBOR.
- SOFR is based on actual transactions, while LIBOR may be based on expert judgment to the extent that banks on the panel providing the data for LIBOR calculations have fewer actual interbank lending transactions to report.
- SOFR is produced in compliance with international best practices and has been deemed compliant with the International Organization of Securities Commissions’ principles for financial benchmarks.
Footnote a Source: AFS Best Practices Leadership Council Webinar Series Presents: LIBOR Update, www.afsvision.com/News-Events/Archives/SOFR-is-Heating-Up,-Get-the-Latest-Update-from-AFS; accessed 8/6/2020
Footnote b Source: AFS Best Practices Leadership Council Webinar Series Presents: 2021, A Year for Transition – Leaving LIBOR Behind, https://afsvision.com/AFS/media/AFS/Documents/Presentations/AFS-Webinar-SOFR-Update_01-20-2021.pdf?ext=.pdf; accessed 3/22/2021
SOFR at Truist
Currently, at Truist we offer daily simple SOFR, 30-day Average SOFR and 90-day Average SOFR, all as reported by the New York Fed. Daily simple SOFR uses an in arrears convention, meaning it’s backward-looking, while Average SOFR is set in advance for the applicable interest period.
We expect to introduce additional rate structures in phases—including SOFR compounded in arrears and, if it’s developed by the market, Term SOFR.
Impact on borrowers with existing loans
If your organization has a LIBOR-based loan that matures prior to the end of LIBOR, there’s nothing you need to do in response to the phasing out of LIBOR.
For loans maturing after the end of LIBOR, it is important that the loan documentation contain language (known as fallback language) that clearly provides for the replacement of LIBOR with another index after LIBOR goes away. Truist is actively engaged in reviewing the fallback language for all LIBOR loans. Over the coming months you will receive information from Truist and your relationship manager about how the end of LIBOR will impact your loan. Some loans have robust industry-recommended fallback language and no further action will be required; they will simply transition to the new index at the end of LIBOR. And some borrowers will be asked to amend their loan documents to add industry-standard language to provide for the replacement of LIBOR. We will contact you regarding any recommended updates for your loan.
Impact on loans with derivatives transactions
If you have a LIBOR-based variable-rate loan and are using a LIBOR-based derivatives transaction—such as an interest rate swap—to create a fixed-rate profile, the impact of the end of LIBOR on both of these must be considered. ISDA, the derivatives industry group, has published robust fallback provisions to be applied to the swap upon the discontinuation of LIBOR. The ARRC has recommended fallback language for hedged loans whereby the loan adopts the conventions in the related swap for the replacement of LIBOR in order to maintain the hedging relationship between the loan and the derivative. Truist has adopted the hedged loan approach in current loan documents. As we review existing loans, if your loan matures after the end of LIBOR and does not currently include hedged loan language, we will be in touch to discuss options for your loan and the associated swap.
What if you're shopping for a new loan?
If you’re currently shopping for a new loan, consider the transition away from LIBOR as you evaluate the rates available to you. While LIBOR rates are currently still available, loans that will mature after the LIBOR end date must contain fallback language and will be required to transition to the replacement rate at the time LIBOR is discontinued.
At Truist there are other reference rate options available for consideration. By selecting an alternative reference rate now, you will not be impacted by the end of LIBOR. We will work with you to determine the reference rate options available to your company.
Say goodbye to LIBOR—and prepare for alternative reference rates
If you have questions about new SOFR pricing options or how the phasing out of LIBOR will impact your current or future Truist loans or derivatives transactions, contact your relationship manager.
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