While much of the focus this summer was on Covid-19, the decline in GDP and the fluctuating UE rates, some pockets of the market kept a different acronym in the mix of hot topics.
Regulators, advisors and trade groups have made significant movement and provided guidance to help banks prepare for the eventual exit of the London Interbank Offered Rate, commonly abbreviated to LIBOR, at the end of 2021. These new updates include best practice recommendations, updated fallback language for loans and key dates to no longer offer new originations in LIBOR.
Why does this matter to community banks? Syndicated loans make up only 1.7% of the nearly $200 trillion debt market that is tied to LIBOR — a figure that includes derivatives, loan, securities and mortgages. Many community banks hold syndicated loans on their balance sheets, which means they’re directly affected by efforts to replace LIBOR with a new reference rate.
A quick history refresher: In 2014, U.S. federal bank regulators convened the Alternative Rates Reference Committee (ARRC) in response to LIBOR manipulation by the reporting banks during the financial crisis. A wide range of firms, market participants and consumer advocacy groups — totaling about 1,500 individuals — participate in the ARRC’s working groups, according to the New York Federal Reserve. The ARRC designated the Secured Overnight Financing Rate (SOFR) as a replacement rate to LIBOR and has been instrumental in providing workpapers and guidelines on SOFR’s implementation.
In April 2019, the ARRC released proposed fallback language that firms could incorporate into syndicated loan credit agreements during initial origination, or by way of amendment before the cessation of LIBOR occurs. The two methods they recommended were the “hardwired approach” and the “amendment approach.” After a year, the amendment approach was used almost exclusively by the market.
In June 2020, the ARRC released refreshed Hardwired Fallbacks language for syndicated loans. The updates include language that when LIBOR ceases or is declared unrepresentative, the-LIBOR based loan will “fall back” to a variation of SOFR plus a “spread adjustment” meant to minimize the difference between LIBOR and SOFR. This is what all other markets are doing and reduces the need for thousands of amendments shortly after LIBOR cessation.
In addition, the ARRC stated that as of Sept. 30, lenders should start using hardwired fallbacks in new loans and refinancings. As of June 30, 2021, lenders should not originate any more loans that use LIBOR as an index rate.
As the market continues to prepare for LIBOR’s eventual exit, BancAlliance recommends banks take several steps to prepare for this transition:
- Follow the ARRC’s recommendations for identifying your bank’s LIBOR-based contracts and be aware of the fallback language that currently exists in each credit agreement. Most syndicated loans already have fallback language in existing credit agreements, but the key distinction is the extent of input the lenders have with respect to the new rate.
- Keep up-to-date with new pronouncements and maintain a file of relevant updates, as a way to demonstrate your understanding of the evolving environment to auditors and regulators.
- Have patience. The new SOFR-based credit agreements are not expected until summer 2021 at the earliest, and there is always a chance that the phase-out of LIBOR could be extended.