By Dan Abdill, Senior Investment Officer (retired)
While other events have captured national and global attention, the transition away from the London Interbank Offered Rate (LIBOR) that began in 2017 continues to move forward. LIBOR’s expected demise is at the end of 2021.
For decades, LIBOR rates have been used globally as reference rates for financial products. U.S. dollar-denominated LIBOR rates have been used as a nationwide benchmark for everything from home mortgages to interest rate swaps. By one estimate, as many as half of the existing contracts using LIBOR will expire after 2021.
In the U.S., LIBOR’s “heir apparent” is the Secured Overnight Financing Rate (SOFR). Regardless of the chosen benchmark, transitioning from LIBOR has its risks. In July 2020, the Federal Financial Institutions Examination Council (FFIEC) – of which the NCUA is a member – released its “Joint Statement on Managing the LIBOR Transition.” The statement enumerates the types of risk examiners will focus on but does not endorse a specific replacement benchmark.
With transition, comes risk
FFIEC’s statement lists many potential risks. The first is an institution’s ability to correctly identify its exposure to LIBOR. Credit unions that use LIBOR as a loan benchmark face consumer protection, litigation and reputational risks related to transitioning existing loans that mature after 2021. While floating rate loan contracts typically contain “fallback” language regarding the replacement of a loan’s benchmark, they are often written with only a temporary replacement in mind. When selecting a permanent replacement benchmark, care must be taken to treat members fairly.
It’s important to note that credit unions that do not use LIBOR as a benchmark for floating rate loans may still be exposed. They may have exposure through investments or third-party service providers.
While SOFR has some advantages as a LIBOR replacement, it also has shortcomings as a benchmark for loans. LIBOR rates have an inherent element of credit risk that SOFR does not. SOFR transactions use U.S. Treasuries as collateral, and are, therefore, considered risk free. The Federal Reserve Bank of New York has convened the Credit Sensitivity Group to address this concern and attempt to find an acceptable, credit-sensitive option to replace LIBOR.
CU preparation is key
As the transition from LIBOR nears, preparation remains essential. Furthermore, the FFIEC statement directly notes that, “While some smaller and less complex institutions may hold little to no LIBOR-denominated assets and liabilities, the change will affect
almost every institution.” So, all credit unions should expect their NCUA exams to address the LIBOR transition to some extent.
To begin preparing, read more about the risks outlined in the FFIEC’s “
Joint Statement on Managing the LIBOR Transition.” In addition to describing the examiners’ areas of focus, the statement includes links to several LIBOR transition resources. For more background on LIBOR, SOFR and the need to transition, check out this helpful blog:
“
From LIBOR to SOFR: 7 Things You Need to Know.” You can also track ongoing results of the New York Fed’s
Transition from LIBOR: Credit Sensitivity Group Workshops as they explore possible loan benchmark alternatives to SOFR.
Catalyst Corporate’s
Brokerage Team aims to inform credit unions of the latest developments within the financial services sector – including the LIBOR/SOFR transition. To speak with one of our experienced Investment Officers,
contact us today.
All securities are offered through CU Investment Solutions, LLC. The home office is located at 8500 W 110th St, Suite 650, Overland Park, KS 66210. CU Investment Solutions, LLC registered with the Securities and Exchange Commission (SEC) as a broker-dealer under the Securities Exchange Act of 1934. CU Investment Solutions, LLC is registered in the state of Kansas as an investment advisor. Member of FINRA and SIPC. All investments carry risk; please speak with your representative to gain a full understanding of said risks. Securities offered are not insured by the FDIC or NCUSIF and may lose value. All opinions, prices and yields are subject to change without notice.