After 2021 (or possibly sooner), most industry experts anticipate that the London interbank offered rate, known as LIBOR, will no longer be published. Currently, the rates of roughly $200 trillion of loans, notes, bonds and derivatives are tied to the U.S. dollar LIBOR interest rate. As the phaseout of LIBOR approaches, markets are preparing to transition these instruments to a new alternative interest rate: the Secured Overnight Financing Rate (SOFR). This transition is intended to create greater stability for lenders and borrowers alike.
What is SOFR and how does it differ from LIBOR?
SOFR, which is being recommended by the Alternative Reference Rates Committee (ARRC), a committee of private-market participants convened by the Federal Reserve Board and the Federal Reserve Bank of New York (“New York Fed”), is derived from interest rates charged in actual transactions in short-term loans backed by U.S. Treasury bonds. By contrast, LIBOR relies on a panel of banks to provide estimates of the interest rate at which they would be prepared to lend money to another bank. The number of actual interbank LIBOR loans has decreased so substantially since the benchmark’s establishment in 1969 that the Federal Reserve estimates LIBOR may currently be based on an average of fewer than 10 transactions per day. As a result, it’s difficult to judge how accurately LIBOR reflects the conditions in the short-term lending market that it’s supposed to represent. This situation contributed heavily to regulators’ plans to phase out the rate.
SOFR improves on LIBOR in two key ways:
- SOFR is calculated based on real transaction data in the overnight Treasury bond repurchase (known as “repo”) markets, which collectively account for roughly $1 trillion of transactions per day. Relying on real transaction data reduces the uncertainty and margin for error in arriving at a number based on multiple estimates.
- The short-term loans used in the SOFR calculation represent common transaction types currently in use by banks, broker-dealers and hedge funds in the United States, making it a more accurate reflection of banks’ actual borrowing costs than the much smaller number of transactions underpinning LIBOR rate estimates.
Since April 2018, the New York Fed has been publishing the SOFR daily, giving markets a tangible comparison between LIBOR and SOFR. The New York Fed also retroactively calculated historical indicative SOFR data covering the period of August 2014 through March 2018 to aid organizations as they develop a plan to transition away from LIBOR.
How we’re preparing
M&T Bank’s planning for the transition away from LIBOR is on track. While a transition to SOFR is likely, it is not yet a certainty. We’ve established an internal team to monitor industry developments and ARRC guidance about the transition. As that process unfolds, we’ve been watching for three key milestones:
- The ARRC supplied recommended fallback language to serve as a framework for syndicated loans at the end of June.
- ARRC guidance on recommended fallback language for bilateral loans is expected shortly.
- The International Swaps and Derivatives Association (ISDA) is expected to issue its change in definitions for protocols covering swaps.
What to expect
At M&T, we intend to follow industry guidelines and best practices to the greatest extent possible, and to undertake this transition in an orderly and transparent manner to facilitate a fair and equitable solution for M&T and its customers. Given the ARRC’s current timeline and the large number of LIBOR-based loan amendments we will need to process, we expect the transition from LIBOR to SOFR to be a significant undertaking.
This transition will require preparation and adjustment by M&T and its customers. However, the shift will help avoid unanticipated and negative consequences for all parties and is likely to produce greater long-term stability in the loan market.
If you are an M&T client with LIBOR-based products, you should expect to hear from us in the coming weeks and months as we reach out to begin discussions about the transition and help guide you through the process. Our goal is to ensure we transition all your LIBOR-based products on or before December 31, 2021.
Because SOFR rates have generally tended to be slightly lower than LIBOR rates, the spread between SOFR rates and your loan rate will likely be greater than the current spread between LIBOR rates and your loan rate. That difference will be remedied by an additional spread adjustment that will have to be added to SOFR to facilitate a comparable loan rate. While we intend to follow industry best practices to produce a value-neutral transition, it is possible that your loan costs may change during the transition.
Steps you can take
There are three key ways you can ensure your organization is ready for the transition away from LIBOR:
- Take an inventory of all your loans and swaps so you know which, if any, will be affected by the transition.
- Make sure your systems are ready for the transition. If you have internal models, make sure you consider the impact of a change to your benchmark from LIBOR to SOFR.
- Bring all stakeholders in your organization up to speed on the change to aid preparation and reduce the potential for surprises.
We’re here to help
M&T Bank can support you in all your preparations, from gathering loan information to walking through how the transition will affect your specific systems. If you have any questions, we’re here to help. Contact your relationship manager for additional information.