What does the end of LIBOR mean for borrowers?

Alan Ganucheau, September 24, 2020

Regulators are sending the London Interbank Offered Rate (LIBOR) packing after 2021. The reference rate that banks have used for decades to price variable-rate commercial loans is being phased out. So what will that mean for borrowers?

Even though there’s still a fair amount of uncertainty about which new reference rate — and which version of it — will emerge as the industry standard, our clients can relax. No matter how this transition shakes out in the coming months, Hancock Whitney is committed to making it as fair and transparent as possible.

Most importantly, when we are required to stop using LIBOR, our goal is to ensure your replacement borrowing rate is substantially equivalent to the previous “all-in” rate on your loan. Similarly, if you have a LIBOR-based variable-rate loan with us and are using a LIBOR-based derivatives transaction — such as an interest rate swap — to effectively fix the interest rate on the loan, when we migrate to a replacement benchmark we are committed to maintaining the effectiveness of fixing the interest rate.

 

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Why the Change?

The shift away from LIBOR is being driven by a desire to transition to a more transparent, market-driven rate based on actual monetary transactions.

After the 2008 financial crisis, systemic changes were made in the global banking system that required banks to focus on liquidity metrics and on-hand liquidity to reduce the amount of inter-related borrowing risk among them. A significant reduction in interbank lending followed, and the dwindling volume of these interbank loans upon which the LIBOR rate is based weakened it as a benchmark based on actual monetary transactions.

As a result, in July 2017, the Financial Conduct Authority, a United Kingdom regulatory body that oversees LIBOR, announced it would no longer compel banks to submit rates for the calculation of LIBOR after the end of 2021. Since then, there has been a global effort to create alternative reference rates for the various currency denominations.

What Will Replace LIBOR?

In the United States, the Federal Reserve, in response to legislative mandates under the Dodd-Frank Act, convened the Alternative Reference Rates Committee (ARRC) to lead that effort. ARRC subsequently recommended a broad measure of the cost of collateralized, overnight borrowing known as the Secured Overnight Financing Rate (SOFR). SOFR is based on a daily volume of about $1 trillion in repurchase agreement transactions secured by U.S. Treasury securities.

Hancock Whitney expects to use SOFR along with other variable-rate indices including Prime and Ameribor, a reference rate published by the American Financial Exchange that’s similar to the federal funds rate.

The current alternative variable-rate indices are subject to resets on each business day and may change based on economic and market activity. But over time, the market is expected to develop additional forward-looking term-rate structures such as 30-day and 90-day term rates for the SOFR and Ameribor indices. In doing so, it will allow borrowers to have their variable interest rate known and fixed at the beginning of each interest calculation period for their loan, similar to the way LIBOR rates are fixed at the beginning of each interest calculation period today.

How Should You Respond?

If you have a loan based on Prime, regardless of maturity, or a LIBOR-based loan maturing prior to the end of 2021, there’s nothing you need to do.

If you have a LIBOR-based loan that matures after 2021, and your loan agreement already has fallback language outlining what happens when LIBOR goes away, no action may be necessary either. On the other hand, in an effort to standardize our loan documents to address the end of LIBOR and make this transition easier for our customers, we may ask some of our borrowers to amend or add such fallback language and sign updated agreements.

Fallback language typically either provides the lender flexibility to determine the replacement rate or establishes a waterfall of replacement rates. For example, it might say that when LIBOR ends, the benchmark becomes a comparable term SOFR; but if that isn’t available yet, the new benchmark becomes overnight SOFR.

If you will be shopping for a new variable-rate loan next year, be aware that based on best practices recommended by ARRC, we expect to stop offering LIBOR as a reference rate sometime in the second half of 2021.

Fair and Transparent

Mandated by regulators, the shift away from LIBOR, a well-entrenched lending reference rate, will take some time and effort. But Hancock Whitney is working to make the transition as fair and equitable as we can for everyone.

We also want to be open and transparent about these changes and how they may impact some of our clients’ loans and derivatives transactions. So if you have any questions, please contact your relationship manager.