London Interbank Offered Rate Information
The dissolution of the London Interbank Offered Rate (LIBOR) impacts all borrowers and banks that use LIBOR as a base rate. LIBOR will continue to be published until June 30, 2023, however, banks are no longer allowed to issue new LIBOR-based products after December 31, 2021.
First Business Bank selected the Secured Overnight Financing Rate (SOFR) as a replacement rate. For more information, please access our two podcasts on the topic: An In-Depth Look at LIBOR & SOFR and Navigating the Transition from LIBOR to SOFR or read the LIBOR and SOFR frequently asked questions below.
What Is LIBOR?
The London Interbank Offered Rate or “LIBOR” is a variable interest rate and financial benchmark, based on the rate at which banks lend to one another on an unsecured basis in the London interbank market. LIBOR is ubiquitous among loans, interest rate swaps, and other financial products.
Why Should I Care About LIBOR?
You or your company may have entered into a loan, and in some cases an interest rate swap, with First Business Bank in which your interest or floating rate payments are based on LIBOR.
In accordance with guidance issued by the Bank’s regulators:
- As of December 31, 2021, First Business Bank will no longer enter into or extend any loan, interest rate swap, or other contract that references LIBOR.
- Beginning on July 1, 2023, First Business Bank will no longer be able to rely on LIBOR as a benchmark in any contract, and as a result, the Bank and its customers will need to replace all references to LIBOR in existing contracts that go past that date.
What is SOFR?
The Alternative Reference Rate Committee or “ARRC” (a public-private working group convened by the U.S. Federal Reserve) recommended the Secured Overnight Financing Rate or “SOFR” as a replacement for LIBOR in the U.S. There is no requirement to adopt SOFR, but many banks and other market participants in the U.S. are expected to rely on a version of SOFR as a replacement for LIBOR. This may include Term SOFR, 30-Day Average SOFR, Daily Simple SOFR or Compounded SOFR (among other variations on SOFR).
In addition to SOFR, First Business Bank may also offer other benchmark rates as substitutions for LIBOR, including BSBY and Ameribor.
First Business Bank also may add a mathematical adjustment to any of the above-referenced replacement rates to maintain an economic outcome as similar as possible to the original LIBOR-based transaction, recognizing that economic equivalence is likely impossible.
What Do I Need To Know About SOFR?
SOFR is a broad measure of the cost of borrowing cash overnight, collateralized by U.S. Treasury securities in the repurchase (repo) market. SOFR differs from LIBOR in several ways, including that SOFR is a secured rate (LIBOR is unsecured), it is a compounded overnight rate (LIBOR is a term rate), and the two rates are based on entirely different markets. Term SOFR, referenced above, is intended to look more like LIBOR in that it is a forward-looking term rate for any given interest period, and it is published by the CME Group and recommended by the ARRC.
Bloomberg Short-Term Bank Yield Index (BSBY) is based on the average yields at which large global banks access USD senior unsecured marginal wholesale funding. It is a forward-looking term rate with credit sensitivity.
American Interbank Offered Rate (Ameribor) is based on overnight unsecured loan transactions on the American Financial Exchange. It is intended to reflect the actual borrowing costs of small, regional banks in the U.S.
How Will Replacing LIBOR Actually Work?
Bilateral and Syndicated Loans:
For LIBOR-based loans that extend past June 30, 2023, robust “fallback” terms are included in the loan documents to ensure that a valid interest rate governs loan documents when LIBOR is no longer a viable index. These fallback terms must include:
- The triggering events that will lead to LIBOR being replaced (including the index no longer being published, or the relevant regulator determining that LIBOR is no longer “representative” of the underlying market);
- The LIBOR replacement rate, plus any mathematical adjustment to the replacement rate; and
- The effective date on which LIBOR will be replaced with a new rate.
If a loan is hedged, it is generally in both the borrower’s and lender’s interest that the interest rate in the loan remains the same as the interest rate in the related interest rate swap, so that LIBOR is replaced at the same time and with the same replacement rate in the loan and the swap. As a result, hedged loans that reference LIBOR may include language stating that the LIBOR replacement terms set forth in the related interest rate swap (including the replacement rate, any adjustment thereto, and the timing of the replacement) will apply to the loan as well.
Swaps and Other Derivatives Transactions:
Unlike loans, an industry-wide, streamlined solution to replace LIBOR exists for derivatives transactions. The International Swaps and Derivatives Association or “ISDA” has created a dual-pronged approach to insert robust LIBOR fallback terms in all derivatives. This includes (i) an update to the 2006 ISDA Definitions, which automatically applies to derivatives transactions executed on and after January 25, 2021, that incorporate such Definitions, and (ii) a protocol incorporating such amendments into derivatives transactions executed prior to January 25, 2021.
The fallback terms that will be inserted into derivatives transactions via the ISDA amendment and Protocol state that when LIBOR stops being published by the ICE Benchmark Administration, or when the FCA (Financial Conduct Authority) has determined that LIBOR is no longer representative of the underlying London interbank market, LIBOR will be replaced by Compounded SOFR plus a mathematical adjustment published by Bloomberg.
What Do I Need to Do Now?
Every LIBOR-based credit facility and interest rate swap that extends beyond June 30, 2021 will include robust fallback terms to account for the transition away from LIBOR. Without these fallback terms, there is significant uncertainty and the potential for disagreement between loan parties on how to replace LIBOR when it stops being published or is deemed as no longer “representative” by the FCA.
First Business Bank is working with each client to ensure that its LIBOR-based loans and derivative transactions, whether already executed or to-be-executed, incorporate the appropriate fallback terms. To accomplish this, the Bank is contacting its customers to (i) execute simple bilateral amendments to existing loan documentation, (ii) adhere to the ISDA protocol (discussed above), and (iii) insert the appropriate LIBOR fallback terms in new loan documentation.