The London Interbank Offered Rate (LIBOR)—the reference rate financial institutions have used for decades to price variable-rate commercial loans—is being phased out. So what does that mean for companies that either currently have a loan based on LIBOR or are shopping for a new loan?
In July 2017, the Financial Conduct Authority, which oversees the publication of LIBOR, suggested it might end its support for maintaining the LIBOR rate-setting process as soon as the end of 2021. As a result, regulators and market participants have begun to contemplate the possibility that LIBOR may cease to exist beyond that date and have initiated a global effort to create alternative reference rates (ARRs).
In the United States, this initiative has been led by the Federal Reserve, which has convened the Alternative Reference Rates Committee (ARRC), made up of major market participants. The ARRC, tasked with developing an ARR for use in the US, has recommended a broad measure of the cost of collateralized, overnight borrowing known as the Secured Overnight Financing Rate (SOFR). In April 2018, the Federal Reserve Bank of New York began publishing SOFR.
SOFR is a secured risk-free rate based on a daily volume of approximately $1 trillion in underlying US Treasury repurchase transactions.
This table highlights key differences between LIBOR and SOFR:
|An unsecured reference rate reflecting bank cost of funds||A secured risk-free rate based on U.S. Treasury repurchase transactions|
|Forward-looking and different maturities: overnight, one week, one month, two months, three months, six months and one year||Backward-looking overnight rate|
|Based on an average daily volume of interbank LIBOR-based loans of approximately $500 million||Based on a daily volume of approximately $1 trillion in underlying U.S. Treasury repurchase transactions|
A paced, structured transition away from LIBOR is underway. The growth of the SOFR futures market and increased volume of new SOFR-linked floating rate notes are promising.
While it's clear LIBOR is going away after 2021, there remains uncertainty about what rate or rates ultimately will replace it. SOFR will likely be used as one replacement rate, but it may not be the only one. Truist will be ready to use SOFR going forward, but we're considering other alternatives as well.
So what does this all mean for borrowers?
If you currently have a LIBOR-based loan maturing later than the end of 2021, the impending phase-out of LIBOR means you'll likely need to sign paperwork from your lender that amends your loan agreement to allow for a future shift to a new benchmark rate.
If you're currently shopping for a new, variable-rate loan prior to the phase-out, you can choose to tie the pricing to LIBOR or some other index such as the prime rate. If you decide to make it a LIBOR-based loan, the agreement will likely include "fallback language" enabling the shift to a new index when a change becomes necessary.
Let us be your guide
We're working to ensure that our clients and our firm are prepared for the transition by the end of 2021. With the phase-out of the index used for variable-rate loans on the horizon, Truist will keep you apprised of any action required on your part—such as signing new loan agreements or addendums.
We encourage you to contact your Truist relationship manager with any questions you have about the transition or available benchmark rates for your loan or loans going forward.
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