- Review and identify current loans, including syndications and participations, that utilize LIBOR and any proposed substitution interest rates.
- Even if a LIBOR loan is scheduled to mature before the transition, review in case the loan is amended or deferred in light of the current COVID-19 pandemic.
- Determine an appropriate LIBOR substitute, depending on the type of loan.
- Review internal loan policies for LIBOR transition planning.
- Modify loan documents as necessary.
The Federal Financial Institutions Examination Council (“FFIEC”) recently highlighted the risks of the expected phase-out of the London Interbank Offered Rate (“LIBOR”). LIBOR has long served as an international reference rate for various commercial and financial contracts, including corporate and municipal bonds and loans, floating rate mortgages and consumer loans. It is expected that a number of banks currently reporting information used to determine LIBOR may stop doing so after 2021, when their current reporting commitment ends. That could either cause LIBOR to stop publication immediately or cause the Financial Conduct Authority, LIBOR’s regulator, to determine that its quality has degraded to the degree that it no longer represents its underlying market. This is especially important because many loans are being amended, deferred, and/or extended given the current COVID-19 (coronavirus) pandemic, as well as the proposed use of LIBOR in COVID-19 government lending programs, such as the Main Street Lending Program. Based on these changes, it is important to focus on what your bank will do regarding LIBOR in the future.
Accordingly, banks should review their loans that utilize LIBOR and prepare for an appropriate transition to a substitute rate.
FFIEC Identified Risks
The FFIEC statement urges banks to plan carefully to avoid both financial losses and consumer harm. The statement highlights potential risks of the LIBOR transition, including:
- Operational difficulty in quantifying exposure;
- Financial, valuation, and model risk related to reference rate transition;
- Inadequate risk management processes and controls to support transition;
- Consumer protection-related risks;
- Limited ability of third-party service providers to support operational changes; and
- Potential litigation and reputational risk arising from a reference rate transition.
Managing the LIBOR Transition
If you haven’t already done so, it is critical to prepare for the LIBOR transition and to take proactive measures, including the following:
- Assessment: Identify and quantify your LIBOR exposure so that management can better understand and address the risks of LIBOR’s discontinuation. Evaluate verbiage in financial contracts concerning LIBOR’s discontinuation to mitigate risk. Consider discontinuing the origination and purchase of LIBOR-indexed instruments.
- Contract Verbiage: Assess existing contracts and determine if they have adequate rate-fallback language. In new contracts, substitute alternative rates for LIBOR, or provide robust fallback language to avoid both legal and safety and soundness risk. In the recent flurry of subordinated debt offerings for banks on which we’ve worked, Secured Overnight Financing Rate (“SOFR”) was frequently referenced as the fallback rate, and we’ve developed appropriate contract verbiage to address these issues. Although it appears that SOFR is becoming the most common alternative to LIBOR, we urge you to monitor developments with SOFR as the industry continues to develop the new “standard.”
- Consumer Impact: Evaluate the legal, operational and other risks associated with consumer financial products that will be impacted by the transition. Develop transition plans that identify consumer loan contracts, highlight risk mitigation efforts and provide for clear and timely consumer disclosures prior to a reference rate change.
- Third-Party Service Providers: Evaluate reliance on third-party service providers that offer valuation/pricing services in reliance on LIBOR, and whether third parties can accommodate alternative reference rates. If you believe that a provider cannot accommodate changes, you should evaluate your contract with that provider and take all appropriate actions, including possibly terminating the contract. Evaluate third parties that provide modeling, document preparation, accounting or other potentially impacted services. Assess the preparedness and transition planning of such third parties.
- Supervisory Activities: Prepare to discuss LIBOR exposure, related risk assessment and specific transition planning, among other matters, during regularly scheduled examinations and monitoring activities. Regulators will ask banks to detail various aspects of their transition risk assessment and planning.
We Can Help You
Our Financial Institutions Group is closely following the anticipated LIBOR transition and is currently counseling our banking clients on the possible alternatives, including SOFR. Additionally, we have been advising clients on potential weaknesses in LIBOR transition planning. Please call us if you have any questions or if we can otherwise be of assistance.
We recommend you evaluate the following pandemic-related business and legal considerations that we have been discussing with our clients:
- Nicholas M. Brenckman
- Nicholas H. Callahan
- Joseph T. Ceithaml
- Bill Fay
- Robert M. Fleetwood
- John E. Freechack
- John M. Geiringer
- Katherine Fritzi Getz
- Edward F. Malone
- Brent McCauley
- Abdul R. Mitha
- Stanley F. Orszula
- Neil R. Patel
- W. Scott Porterfield
- Brandon C. Prosansky
- John "Jack" W. Roberts
- Andrea L. Sill
- Jack Snyder
- Karol K. Sparks
- Dennis R. Wendte
- Steven J. Yatvin