BYE BYE BYE…LIBOR
In case you haven’t heard, 2021 is set to mark the end of the London Interbank Offered Rate, better known as Libor. We’ve always called it, “the world’s most important number” and now, as it gradually phases out towards the end of next year, we’re all left wondering how its cessation will affect current loans and what this all means for the future.
WHAT IS LIBOR AND WHY IS IT GOING AWAY?
LIBOR is the basic rate of interest used in lending between banks on the London Interbank market and is also used as a reference for setting the interest rate on other loans from mortgages to student loans. It was developed by the British Banker’s Association in the 1980’s as part of an effort to create some type of benchmark interest rate for complexities of swaps and futures whose prices were tied to interest rates. Since its inception, it has always been based on estimates rather than data. Being that transactions among banks don’t occur as often as they did in previous years, the index is less reliable and credible. It has also been noted that as the years went on, some bankers were caught submitting manipulated numbers to make their own banks look healthier. They were fined for their misconduct, but it wasn’t until 2014 when the Alternative Reference Rates Committee was created to come up with a solution. Their solution? Phase it out entirely.
WHY IS THIS A PROBLEM?
The unknown can be scary and there is more at stake than one might think. The Libor change could effect trillions of dollars in deals based on floating interest rates. For projects that are not yet generating revenue, borrowers take out floating-rate loans where the interest rate is typically linked to Libor plus a spread. These have become increasingly popular as interest rates have decreased. Without Libor, the interest rate to be paid on any given loan could be higher or lower than lenders and borrowers anticipated when they originally signed their deal.
WHAT SHOULD YOU DO TO PREPARE?
- Review language in existing loan documents to make sure it addresses the change from LIBOR to another benchmark rate and assess the impact.
- Work with a lender to understand your current financial exposure – the size of activity tied to USD LIBOR across all financial products.
- When buying property with debt, stop taking new loans using LIBOR and start using SOFR* or another alternative.
*The Federal Reserve has appointed the Alternative Reference Rates Committee (ARRC) to determine what the alternative will be and their proposal/solution is SOFR. SOFR, or Secured Overnight Financing Rate, is a measure of the cost of borrowing cash overnight against Treasury securities, and it has been published by the Federal Reserve Bank of New York since 2018. It is generally a marginally lower rate. Unlike LIBOR, which has been increasingly based on estimates in the wake of the financial downturn, SOFR is a secured daily rate known as an “overnight rate”, which is based on an observable market with a daily trading volume of more than $1 trillion.
As we get ready to say “Bye, Bye, Bye” to LIBOR, clients are being encouraged to examine their loan documents and contracts to figure out the future of the terms. In order to ensure a smooth transition, make sure you’re educated in the differences and that all new loans have either a fallback clause or do not use LIBOR.
Progress is here to help answer your questions and provide you with the best possible option for your financing needs.
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