The Transition Away from LIBOR
The U.S. financial system is undergoing a massive and complex transition away from the London Interbank Offered Rate, commonly known as LIBOR. LIBOR is a benchmark interest rate that is referenced in trillions of dollars of financial contracts, such as business and consumer loans, interest rate derivatives, adjustable rate mortgages and floating rate notes. Rest assured, work and planning on this transition away from LIBOR has been underway for the past several years as the end of LIBOR is nearing.
As a client of Old National Bank, we want to assure you that we stand ready to answer your questions and partner with you as we work through this transition together. The following FAQ guide is meant to help answer commonly asked questions about this change. If you have specific questions about how this transition will affect you, please reach out to your Old National relationship manager.
Why is LIBOR being discontinued?
LIBOR was introduced in the 1980’s as a benchmark interest rate that was intended to reflect banks’ average cost of short-term, wholesale unsecured borrowing. Over time, and particularly during the financial crisis that began in 2007, banks became less and less reliant on inter-bank lending. As a result, the number and dollar volume of transactions from which LIBOR was derived declined dramatically. To make up for this shortfall, LIBOR panel banks resorted to using “expert judgment” when submitting various rates used in calculating LIBOR. This left it susceptible to manipulation and fraud.
In 2017, the UK Financial Conduct Authority (FCA), the regulator for LIBOR, announced that after December 31, 2021, the panel banks would no longer be required to submit settings for LIBOR. (This has since been revised to June 30, 2023, for most LIBOR tenors.) This announcement effectively started the countdown to the end of LIBOR.
There are two main deadlines for the discontinuance of LIBOR. First, the banking regulators including the Office of the Comptroller of the Currency (OCC), the Federal Reserve Bank (Fed) and Federal Deposit Insurance Corporation (FDIC), have directed banks to stop using LIBOR in new financial contracts as soon as practicable, but no later than December 31, 2021. Secondly, for all existing contracts that mature after June 30, 2023, LIBOR will need to be replaced with a new benchmark interest rate.
We suggest reviewing your loan documents to see if LIBOR is used as the reference rate or contact your Old National relationship manager who can assist you. If your loan contract references LIBOR, then this transition affects you.
Although options for replacing LIBOR continue to evolve, Old National has currently identified the following potential replacement options for our clients:
- Secured Overnight Financing Rate (SOFR)
- AMERIBOR® Term–30
- Bloomberg Short Term Bank Yield (BSBY) Index
The Secured Overnight Financing Rate or SOFR is the replacement benchmark recommended by the New York Federal Reserve’s Alternative Reference Rate Committee (ARRC). (See references below for more information on the work of the ARRC.) SOFR is derived from transactions that are executed in the overnight repurchase agreement (repo) market. These transactions are executed between banks and other intermediaries and are often collateralized by US Treasury securities. The market for SOFR is very deep and liquid with nearly $1 trillion in underlying transactions executed daily. Since transactions are secured by US Treasuries, SOFR is considered a “risk-free” benchmark that may not capture changing risk conditions the same way that AMERIBOR® Term–30 or BSBY might. It is expected that SOFR will be the most widely accepted and utilized replacement benchmark.
AMERIBOR® Term–30 was developed by the American Financial Exchange (AFX) as a potential replacement for LIBOR. AMERIBOR® Term-30 is derived from transactions that are executed on the AFX, commercial paper issued by bank holding companies, and wholesale, unsecured bank issued certificates of deposit. Like LIBOR and unlike SOFR, AMERIBOR® Term-30 incorporates a risk component and is meant to be a better reflection of a bank’s cost of funds.
The Bloomberg Short Term Bank Yield Index or BSBY is a benchmark developed by Bloomberg Financial Services. Once again, it has similarities to AMERIBOR® Term–30 and LIBOR and is meant to capture changing credit conditions more accurately.
Old National has thoroughly analyzed and evaluated these replacement benchmarks. Our goal is to provide you several sound options since one size does not fit all. The replacement benchmarks noted above have different characteristics, advantages, and disadvantages. Your Old National relationship manager will work with you to decide which alternative best fits your needs.
It is currently anticipated that we will not use LIBOR as a benchmark after October 31, 2021, for any new or renewed loans.
My loan contract matures after June 30, 2023. What happens if I choose not to do anything to amend my contract to incorporate a LIBOR replacement benchmark before that time?On June 30, 2023, LIBOR will cease to exist as a reference rate in all financial contracts. This means that all existing loans referencing LIBOR will automatically convert or “fallback” to a new, replacement benchmark. Old National will notify you of the new replacement benchmark selected for your loan.
When the benchmark in my loan is changed from LIBOR, will the “spread” over the benchmark also change?
Yes, possibly. One of the overarching goals of the LIBOR transition is to ensure that there is no “value transfer” between two parties to a contract simply because the benchmark interest rate has changed. Since no replacement benchmark is the same as LIBOR, it is possible that a “spread adjustment” will be required to ensure there is no value transfer from one party to the other.
For example, it was noted above that SOFR is a “risk free” rate while LIBOR is not. This means that SOFR is usually lower than LIBOR. To make these rates comparable, the financial industry, through the work of the ARRC, established certain spread adjustments that would be added to SOFR for each LIBOR tenor. These spread adjustments are noted below and will be added to SOFR automatically unless the loan contract is renegotiated prior to June 30, 2023:
Your Old National relationship manager will be able to answer any specific questions you may have about a spread adjustment that may be required on your loan.