Is LIBOR being phased out?
Yes. On March 5, 2021, Ice Benchmark Administration (the “IBA”), the administrator of LIBOR, stated that as a result of its not having access to input data necessary to calculate LIBOR settings on a representative basis, it would have to terminate publication of all LIBOR tenors immediately after the below dates:
- 12/31/2021: 1-week and 2-month USD LIBOR tenors; all tenors of LIBOR denominated in foreign currencies
- 6/30/2023: Remaining USD LIBOR tenors (including 1-month LIBOR)
The Financial Conduct Authority (the FCA) also issued a statement on the same date, which confirmed that all of the LIBOR tenors will either cease to be provided by the IBA or will no longer be representative as of the dates set forth above.
*Note: FHN ceased LIBOR-indexed new loan originations on December 31, 2021, in line with U.S. banking regulators’ guidance.
Why is LIBOR being phased out?
LIBOR is meant to reflect the cost at which large, globally active banks can borrow on an unsecured basis in “wholesale” markets. To create the index, a panel of between 11 and 16 banks submit their cost of borrowing on a daily basis. Given changes in market structure, regulatory capital, liquidity requirements and bank risk appetite, few of these transactions occur on a regular basis. Since there are very few actual market transactions, panel banks are increasingly relying on “expert judgment” to estimate the cost of this type of funding. Banks and regulators favor a more independent, market-driven pricing index that eliminates issues such as:
a. Manipulation – The 2012 LIBOR scandal highlighted the vulnerability of LIBOR to manipulation by panel banks.
b. Stressed market conditions – Lending activity between banks typically slows in stressed market conditions such as in the 2008 financial crisis, further reducing or eliminating underlying market activity.
What have U.S. bank regulatory agencies done to prepare for the cessation of LIBOR?
In 2014, the Federal Reserve convened the Alternative Reference Rates Committee (ARRC), which comprises a diverse group of private-sector entities that have an important presence in LIBOR markets such as banks, asset managers, insurers, and industry trade organizations as well as U.S. regulators. The ARRC was charged with leading the LIBOR transition effort by:
- Identifying an alternative rate based on transactions from a robust underlying market
- Developing a plan to facilitate acceptance and use of the recommended rate
- Providing fallback language guidance for loan agreements
In 2017, the ARRC selected the Secured Overnight Financing Rate (SOFR) as its recommended alternative to USD LIBOR. SOFR is an overnight rate that reflects the cost of overnight borrowing and lending in the U.S. Treasury repo market. The Federal Reserve Bank of New York began publishing SOFR in 2018.
The ARRC provides numerous materials related to the LIBOR transition, including an in-depth frequently asked questions document, on its website.
On November 30, 2020, the U.S. banking regulators issued a statement encouraging banks to transition away from offering U.S. Dollar LIBOR for new contracts as soon as practicable and in any event by December 31, 2021.
What are the key differences between LIBOR and LIBOR Alternative Index Rates?
What are the key differences between LIBOR and LIBOR Alternative Index Rates? In addition to the bank’s Prime rate, a well-established benchmark rate for floating-rate loans, the table below provides a summary of other Alternative Benchmark Rates:
| Benchmark Rate | Administrator | Term Rate or Daily Rate? | Credit-Sensitive or Risk-Free |
| LIBOR | Intercontinental Exchange (ICE) | Term Rate | Credit-Sensitive Rate |
| Secured Overnight Financing Rate (Daily SOFR) | Federal Reserve Bank of New York | Daily Rate | Risk-Free Rate |
| CME Term SOFR | CME Group Benchmark | Term Rate | Risk-Free Rate |
| Bloomberg Short-Term Blank Yield Index (BSBY) | Bloomberg Index Services | Term Rate | Credit-Sensitive Rate |
| AMERIBOR® | American Financial Exchange | Term Rate | Credit-Sensitive Rate |
| Defined Terms | |
|---|---|
| Credit-Sensitive Rate | A rate designed to mirror banks’ funding costs that therefore reflects the credit risk of banks. |
| Risk-Free Rate | In the case of SOFR, a rate reflecting the cost of borrowing for loans secured by U.S. government debt. |
| Forward Term Rate | Unlike a daily or overnight rate, a forward term rate is set in advance for a period equal to the rate’s tenor (1, 3, 6 or 12 months). Operationally similar to LIBOR from an accrual and billing perspective. |
| ARRC | The Alternative Reference Rates Committee; convened by the Federal Reserve in 2014 to identify a LIBOR replacement rate.. |
As compared to term rates, daily rates may introduce a compression of the billing cycle by several days. For loans with an index that resets daily, interest accruals cannot be calculated until the end of the interest period (less the number of days in the lookback period).
SOFR reflects the overnight cost of borrowing in the Treasury repo market (secured by U.S. government debt) and has therefore been described as a “nearly risk-free reference rate.” By contrast, BSBY and AMERIBOR® seek to reflect banks’ unsecured borrowing costs and have therefore been described as “credit-sensitive rates.”
Are there different variations of the SOFR benchmark?
Yes. As noted above, SOFR is published on a daily basis by the Federal Reserve Bank of New York. The SOFR rate can be applied to a loan on a daily basis or averages of past daily SOFR rates could be used.
In addition, the CME Group publishes a Term SOFR, which is a forward-looking rate, with 1-month, 3-month and 6-month tenors, and is derived from SOFR futures contracts. The ARRC has issued its final endorsement of this rate in a press release dated July 29, 2021.
What is the difference between Daily SOFR and CME Term SOFR?
CME Term SOFR, similar to LIBOR, is a “term rate,” where the interest rate is known at the start of the accrual period. Using a term rate structure has allowed both lenders and borrowers to easily calculate and project future interest accruals. Unlike a term rate, loans that reference the Secured Overnight Financing Rate (“Daily SOFR”) have a daily interest rate reset. Daily SOFR is published each day for the prior day, and interest accruals are calculated each business day. Borrowers considering Daily SOFR as a benchmark rate should understand the dynamics of moving from a term rate to a daily rate. (Borrowers should understand, for example, that adopting Daily SOFR will introduce a more complex interest calculation and a compression of the billing cycle by several days.) Your First Horizon banker is prepared to discuss these complexities should a daily rate be of interest.
What are the LIBOR Alternative Index Rates?
In seeking alternatives to LIBOR, banks and borrowers have expressed a desire for a benchmark rate that:
- Has a forward-looking term component. That is, the interest rate is known at the beginning of the interest period, which is 1 month (or some other tenor) in length. For many market participants, a forward-looking rate is preferable to an overnight rate, where the interest rate is published each day and where the interest payment can only be calculated at the end of the interest period.
- Can be hedged. Market participants desire a rate on which an interest rate derivative may be placed, if the borrower and lender agree to enter into such a contract.
- Has a credit-sensitive component. Certain market participants are interested in a rate that reflects lenders’ cost of funds.
- Has regulatory endorsement/approval. LIBOR ultimately lost the confidence of U.S. and global financial services regulators because it was prone to manipulation.
Daily SOFR (published by the New York Fed) and Term SOFR (published by CME Group) each satisfy some but not all of the above conditions. As such, certain private benchmark administrators have begun publishing (or plan to publish) additional rates. While none of these privately administered rates have received the official endorsement of the U.S. banking regulators, a letter from the heads of multiple bank regulatory agencies dated October 2020 stated “the official sector supports the continued innovation in, and development of, suitable reference rates, including those that may have credit sensitive elements.”
Two noteworthy privately administered benchmark rates (both of which are transaction-based, rather than being based on expert judgment) are:
- Bloomberg Short-Term Bank Yield Index (BSBY) – Offered by Bloomberg Index Services Ltd, BSBY was launched in January and has five tenors, including 1-month, 3-month, 6-month and 12-month tenors. BSBY seeks to represent the marginal funding cost of large global banks – that is, to measure the average yields at which large global banks access USD senior unsecured marginal wholesale funding. BSBY relies on data anchored in transactions and executable quotes (for USD bank deposits, commercial paper, CDs and secondary market trades for short-term senior unsecured bank bonds) rather than subjective inputs.
- AMERIBOR® – Produced by the American Financial Exchange and launched in 2015, AMERIBOR® is based on overnight, unsecured lending on the American Financial Exchange and reflects the borrowing costs of small, medium and regional banks across America. AMERIBOR® forward-looking term rate tenors include 30-day and 90-day.
Additional privately administered benchmark rates include the Bank Yield Index (BYI) from Ice Benchmark Administration, the current administrator of LIBOR, and the Credit Inclusive Term Rate (CRITR) from IHS Markit, and are in development.
How will the transition from LIBOR impact new adjustable rate mortgage applications?
For adjustable-rate mortgages, Fannie Mae and Freddie Mac have chosen a SOFR-based rate as the replacement for LIBOR. Therefore, First Horizon began transitioning adjustable-rate mortgage products to a SOFR offering. With this transition, new applications for an adjustable-rate mortgage will be based on a 30-day average SOFR rate (not Daily SOFR).
Which rates will First Horizon offer for floating-rate commercial loans?
With LIBOR going away, various alternative benchmark rate options exist. Many clients are familiar with the Prime rate (published by the Wall Street Journal and based on the reported base rate of the largest U.S. banks), which First Horizon will continue to offer. In addition, new benchmark rates have been introduced in the marketplace and will be offered by First Horizon. At this time and subject to change, these include: Daily SOFR, CME Term SOFR, BSBY, and AMERIBOR® Derived Term Rate.
How will the LIBOR transition impact new and renewing floating-rate loans issued by First Horizon?
U.S. banking regulators issued guidance directing banks not to issue new or renewed U.S. Dollar LIBOR-based loans after December 31, 2021.
What needs to happen with my existing LIBOR-based loan(s)?
An important date in this transition is June 30, 2023, which is the date when the remaining tenors of USD LIBOR will cease to be published. If your LIBOR-based loan renews prior to this date, the reference rate will need to be changed to one of the new reference rates, or to the Prime rate. Even if a loan does not mature prior to June 30, 2023, it may be beneficial for the bank and the borrower to move the loan away from LIBOR to one of the alternative benchmark rates in the quarters preceding that final cessation date. If you have one or more existing loans that reference LIBOR, your First Horizon banker will be contacting you in the months to come to develop a plan to reprice the loan(s) on another benchmark rate. In the meantime, please feel free to reach out to your banker directly.
What is “fallback language” and what purpose does it serve in the loan documents?
For most loans priced on LIBOR that have closed since late 2019, First Horizon has included certain fallback language in the related loan documents. Fallback language sets forth an amendment/notice process to transition from LIBOR to an alternative benchmark, including spread adjustment as appropriate. The fallback language will take effect if the loan is not repriced away from LIBOR by June 30, 2023, when LIBOR will cease to be published.
Our fallback language addresses the following:
- LIBOR Cessation – The fallback language acknowledges the June 30, 2023, termination of the remaining tenors of U.S. Dollar LIBOR.
- Replacement Rate – First Horizon’s selection of an index to replace LIBOR will consider ARRC guidance (and ISDA guidance for swapped loans) and industry practice.
- Spread Adjustment – For those loans for which the fallback language will take effect, First Horizon may (depending on the benchmark rate chosen) incorporate spread adjustments to account for historical differences between LIBOR and the replacement index.
The majority of First Horizon’s commercial loans priced on LIBOR will be amended prior to June 30, 2023.
Additionally, for loans priced on one of the new reference rates, fallback language will be included in the loan documents to address the unlikely scenario that the new reference rate ceases to be published at some future date.
Will I still be able to hedge interest rates with derivative products going forward?
FHN Financial will provide alternatives to new interest rate derivative products in the coming months. The derivatives market is evolving frequently given the significant impact of the cessation of LIBOR. Contact your relationship manager for the most up-to-date developments related to this topic.
Let's work on a game plan together.
First Horizon led an informative webinar outlining ways we can help prepare you for the transition away from LIBOR. Please watch the webinar, where you will learn of important information and dates that might impact your business.
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