LIBOR: What are your options after it ends?

A hand flipping a switch

As LIBOR’s retirement approaches, here’s what community banks can do now to prepare for the switch, even if they haven’t settled on which index they plan to use.

By Katie Kuehner-Hebert

The retirement of the London Interbank Offered Rate, or LIBOR, is fast approaching. Community banks that use LIBOR to price certain loans should be assessing an alternative index or method to use after it’s discontinued. And for those using LIBOR for mortgage loans sold to Fannie Mae and Freddie Mac, the switch will come even sooner.

While there are a number of possible alternatives to LIBOR, two indexes have received the most interest from banks, regulatory agencies and investment firms. One, the Secured Overnight Financing Rate (SOFR), is recommended by the Alternative Reference Rates Committee, a group of private-market participants that the Federal Reserve Board and the New York Fed created to aid the transition from LIBOR. The other is AMERIBOR, or the American Interbank Offered Rate.

Quick stat


global currencies are used in the calculation of LIBOR: the U.S. dollar, the British pound, the Japanese yen, the Swiss franc and the euro

Each community bank is free to choose the index or method that suits it best, as long as it’s substantially similar to the bank’s previous index or method, and as long as the bank is prepared to explain its choice to regulators and borrowers.

Considering SOFR?

In March, the Federal Reserve Bank of New York, in cooperation with the Treasury Department’s Office of Financial Research, began publishing 30-day, 90-day and 180-day SOFR averages, as well as a SOFR index, to support a successful transition from LIBOR.

The New York Fed also released information about the policies and procedures related to administration of the SOFR averages and index. The information included the calculation methodology, treatment of nonbusiness days and a revision policy.

Tom Hauck, a managing director of advisory firm ProBank Austin in Toledo, Ohio, says that in conversations with his community bank clients, he’s hearing they’re still very early in the process of preparing for the transition. His clients are telling him that “no definite plans are in place.”

“Having said that, one of my bank clients was contacted by the Federal Reserve, which regulates [the bank’s] holding company, asking questions about their process and what they plan on doing,” Hauck says. “The examiners are starting to ramp up their processes, so banks have to start developing their plans.”

For community banks contemplating using SOFR, he says, they will need to take time to monitor the New York Fed’s SOFR averages and index for each of the averages to determine what kind of correlation each has with the rates of the various terms of the U.S. Treasuries.

“Banks will want to make sure their customers are getting a similar rate as they did before, so they will put an appropriate spread over the index to achieve the similar rate,” Hauck says. “For example, if a customer currently is paying three-month LIBOR plus 200 basis points and the SOFR rate is lower than three-month LIBOR, the bank will have to adjust the spread to keep the customer’s rate the same.”

It will take a number of months of published SOFR rates to adequately determinate the correlation with LIBOR and Treasury rates, so Hauck expects banks won’t make their final determination on whether to use SOFR until the end of 2020 or early 2021.

For community banks making mortgage loans sold to Fannie Mae and Freddie Mac, the Federal Housing Finance Agency announced in February 2020 the following timeline as the GSEs transition away from LIBOR:

  • New language will be required for single-family uniform adjustable rate mortgage instruments closed on or after June 1, 2020.
  • All LIBOR-based single-family and multifamily adjustable-rate mortgages (ARMs) must have loan application dates on or before Sept. 30, 2020, to be eligible for acquisition.
  • Acquisitions of single-family and multifamily LIBOR ARMs will cease on or before Dec. 31, 2020.

Community banks can look to vendors to help them maintain and deliver loan document templates published by GSEs, says Christine Heine, a principal consultant based in St. Cloud, Minn., for Wolters Kluwer’s Compliance Center of Excellence.

For national and regional banks managing their own release cycle, changes to language pertaining to the LIBOR switch was in Wolters Kluwer’s March release of the updated loan document templates, Heine says. For community banks that do not manage their own release cycle and use Wolters Kluwer’s ComplianceOne software solution to generate compliant loan documents, documents with updated language were in its April software update.

“In the short term, banks need to decide what they will replace LIBOR with, because they will no longer be able to use it on agency paper with an application date after Sept. 30,” Heine says. “If they are already using some other index in addition to LIBOR, that may be easy: Just only offer the other index. But if banks need to add another index, there could also be changes to marketing materials and their calculations systems or processes.”

Considering AMERIBOR or another method?

In February, 10 banks wrote a letter to banking regulators that AMERIBOR would work better for them than SOFR, which requires borrowers to post collateral like U.S. Treasuries for the secured rate.

The group of banks, which according to Bloomberg have assets ranging from $8 billion to $60 billion, wrote that they “do not have large holdings of government securities and therefore can only borrow on an unsecured basis. That presents an immediate asset-liability imbalance and potentially creates distortions in times of financial stress.”

That means that when there’s a financial crisis, the authors wrote, “overnight liquidity becomes a priority and the value of collateral would rise, leading to increased borrowing costs for banks irrespective of their asset size and affecting credit availability.”

While the 10 banks that submitted the letter are larger than the average community bank, the collateral issue they raise would also affect smaller banks, Hauck says. “This is one reason why moving to SOFR is not a slam dunk and is why the smaller banks are waiting to see how this process plays out and are not in a hurry to implement a plan in 2020,” he adds.

Heine applauded the 10 banks’ request to discuss this challenge with regulators, so that the benchmark options and the impacts on the industry can be more thoroughly vetted. She advises smaller banks to consider participating in the Federal Reserve Board’s weekly conference calls, where David Bowman, the board’s senior advisor, answers questions submitted in advance about the LIBOR transition. “These challenges all the more argue for examining your own bank’s practices and needs to determine a plan for effectively transitioning away from LIBOR,” she says.

Anna Kooi, national financial services practice leader in the Chicago office of Wipfli LLP, says many CPA and consulting firms’ community bank clients are sharing that SOFR doesn’t work for them and that they’re looking to alternatives. Like the aforementioned 10 banks, community banks typically do not have large holdings of government securities and borrow on an unsecured basis. Consequently, moving to SOFR could cause asset-liability imbalance.

“Since the larger banks haven’t fully disclosed or determined their direction on this, I believe community banks will definitely be followers,” Kooi says. “So at this point, they are keeping watchful eyes and ears to see what they can learn.”

“At this point, [community banks] are keeping watchful eyes and ears to see what they can learn.”
—Anna Kooi, Wipfli LLP

What to do now

In the meantime, Kooi advises that community banks should identify all LIBOR-based credits and amend their loan documents so that references to LIBOR are removed and replaced with language concerning an alternate index. Such language can be more general, as opposed to specifically mentioning an alternative if the bank still hasn’t determined what that would be.

Community banks should stay informed on changes and indexes being discussed by big banks. They should also keep open communications with any relationships they may have at larger banks, Kooi says.

“Other than getting their loan documents modified or identifying those loan agreements, which will create a problem when LIBOR is no longer the index,” she says, “patience may be the order of the day.”

6 steps for transitioning from LIBOR

The shift from the London Interbank Offered Rate (LIBOR) to a new index or method will take careful examination of a bank’s loans, systems and more. According to information services and solutions provider Wolters Kluwer, here are some of the steps community banks should take:

  1. Establish a project team, including legal and compliance staff, to prepare for the shift.
  2. Identify the bank’s products, risk models, systems and documentation currently using LIBOR.
  3. For legacy loans that have not reached their end date:
    • Collect and review fallback language and determine how far back will be necessary. This will depend on the remaining term on legacy contracts.
    • Decide which index and margin to use. Consider whether different approaches are needed based on fallback language variation across products.
    • Decide whether to seek amendments through agreement from borrowers.
    • Consider ways to reduce litigation risks.
    • Based on the approach taken with legacy loans, plan to adjust financials accordingly.
  4. For loans executed in the future:
    • Decide which index and margin to use.
    • Decide whether to adopt the fallback language recommended by the Alternative Reference Rates Committee.
  5. Plan for communications internally and to borrowers, such as educational, potential contract amendments and notification of an index change.
  6. Prepare to report to regulators on LIBOR transition preparedness.

Katie Kuehner-Hebert is a writer in California.