04.19.21 | Assurance Chat
When is this really happening? For most loans and interest rate swaps you have some time. By the end of 2021, only the one-week and two-month USD London Interbank Offered Rate (LIBOR) rates will disappear. If your existing loans and interest rate swaps (aka “legacy contracts”) reference the overnight, one-month, three-month, six-month, twelve-month USD LIBOR rates, they will be around until 2023. This timing is good news. Many contracts will not need to be renegotiated, since they will mature timely.
What happens if you need to refinance or enter into a new loan or interest rate swap? The Federal Reserve, FDIC, and Office of the Comptroller of the Currency stressed that banks should stop entering into new contracts referencing USD LIBOR as soon as practicable or at the latest by the end of 20211. Make sure your contract has fallback language referencing a rate other than LIBOR or at least has alternatives.
What are the banks going to use as the new reference rate? The Alternative Reference Rates Committee (ARRC), comprised of the Federal Reserve Bank and the Federal Reserve Bank of New York (FRBNY), selected the Secured Overnight Financing Rate (SOFR) in 2017. SOFR is a rate based on the overnight repurchase market, the market where banks borrow over $1 trillion overnight. The FRBNY began publishing the daily SOFR three years ago on April 2, 2018 and have expanded to the SOFR Averages, which are compounded averages of the SOFR over rolling 30-, 90-, 180-calendar day periods, and the SFOR Index, which allows for custom compounded SOFR averages2.
What are some differences between LIBOR and SOFR3?
|Basis - $1B transactions daily||Basis - $1T transaction daily|
|Forward looking||Historical data|
|Relies on bank submissions and judgment - estimated||Relies on transactions data - observable|
|Unsecured||Secured with Treasuries|
|Credit risk - bank-to-bank lending rate||No credit risk – risk free rate|
|Term structure||No term structure|
|Potentially more volatile||Less volatility the longer the reference interest period|
What should I be doing now to grasp what this change means to me?
Start assessing immediately!
- Identify what contracts you have that reference LIBOR, noting the maturity of the debt. Examples include, but are not limited to, adjustable rate commercial and residential mortgages, interest rate swaps, and, on a more personal note, student loans.
- Understand if there are alternative rates or is there fallback language integrated into the contracts or amendments. If there is only one alternative, find out if there will be a substitution.
- If there is no applicable language, contact the bank to start discussions and begin to determine what the best approach will be to ensure a smooth transition and avoid a potential mismatch between the loan and related interest swap, if applicable.
- Understand the accounting ramifications of any changes. For GAAP financials, is this a debt modification or extinguishment? Can I apply the optional practical expedients in my financial statements based on US generally accepting accounting principles? Are there tax implications for either tax or GAAP financials to discuss with your tax advisor?
- Make sure that all new contracts incorporate alternatives to LIBOR.
- Consider whether or not you will need to make modifications to any systems or methods of calculations.
Questions? I can be reached at 516.806.1193 | BMannFalk@berdonllp.com or reach out to your Berdon advisor.
Bonnie Mann Falk is a Partner in the Quality Control (QC) Department of Berdon LLP with nearly 30 years of experience in public accounting and expertise in a variety of areas including quality management, compliance, and risk management. As a QC Partner, Bonnie advises the Firm on policies and procedures to enhance quality, increase efficiency, and elevate communication.
1 Statement on LIBOR Transition, November 30, 2020, Federal Reserve.
2 SOFR Averages and Index Data, Federal Reserve Bank of New York
3 LIBOR VS SOFR, Pensford