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Why is LIBOR going away?
For decades the London Interbank Offered Rate (LIBOR) has been one of the world’s most widely used benchmark rates, representing a global market with approximately $200 trillion of outstanding contracts.
However, over time the calculation of LIBOR has increasingly relied on the judgment of a panel of large banks given limited underlying transaction. In 2012, LIBOR was found to have been manipulated by several panel banks. Given regulatory concerns related to LIBOR's transparency and reliability, regulators are requiring a market-wide transition away from LIBOR to a more durable and robust interest rate benchmark that is based primarily (if not exclusively) on actual borrowing transactions. This transition is occurring globally.
When is LIBOR going away?
Regulators expect banks to cease using LIBOR as an index for new instruments or renewals of existing loans or other financial instruments by December 31, 2021.
Existing instruments tied to LIBOR must be moved to another index on or before June 30, 2023, when publication of LIBOR rates will cease, and regulators have stated that even if some form of LIBOR continues to be published, LIBOR will be “non-representative” and cannot be used as an index after that date.
What index is expected to replace LIBOR?
The Secured Overnight Financing Rate (SOFR) has been the leading contender to replace LIBOR. The Alternative Reference Rates Committee (ARRC) - an industry group convened by the Federal Reserve Board and the Federal Reserve Bank of New York to identify an alternative reference rate and ensure a successful transition from LIBOR - recommends using SOFR which is considered a more robust reference rate than LIBOR as it is based on transactions and represents an active daily market.
Overnight SOFR rates have been published by the Federal Reserve Bank of New York since April 2018. In July 2021, the ARRC endorsed forward looking Term SOFR rates published by the Chicago Mercantile Exchange. Overnight SOFR rates operate similarly to the Prime rate as the benchmark rate can change daily. Term SOFR rates operate similarly to LIBOR in that the interest rate is known at the start of each repricing period.
Overnight SOFR is based on transactions in the U.S. Treasury repurchase, or repo, market, where banks and investors borrow or lend Treasuries overnight. Underlying transactions had an average daily volume of approximately $900 billion in October 2021.
Term SOFR rates provide an indicative, forward-looking measurement of SOFR rates, based on market expectations implied from leading derivatives markets.
Although LIBOR and SOFR reflect short-term borrowing costs, they are calculated very differently:
• LIBOR is an unsecured rate, has a credit risk component, is set by panel banks, and is heavily impacted by panel bank judgment.
• SOFR is a secured rate, is considered risk free, and is based entirely on actual transaction data.
• As SOFR is risk free whereas LIBOR has a credit risk component, a spread adjustment when replacing LIBOR with SOFR as the index in a financial transaction. The ARRC’s recommended spread adjustments are based on the 5-year median difference between LIBOR and SOFR. The recommended spread adjustment for 1 month LIBOR, for example, is 11.448 basis points.
New Loans or Lines of Credit
For new floating rate loans or lines closed after December 15, 2021, CapStar will offer primarily Term SOFR or the Prime rate as the index.
How will this impact my current loan or line tied to LIBOR?
You do not need to take any action at this time.
Existing LIBOR-based loans and lines of credit will continue to use LIBOR as the benchmark interest rate until LIBOR is no longer published or is deemed non-representative, currently scheduled for June 30, 2023.
If you have a LIBOR-based loan or line that matures after June 30, 2023, we will contact you well in advance – likely in 2022 - if we determine that an amendment to the agreement’s fallback language is needed to ensure a smooth transition from LIBOR to another index on June 30, 2023 and you will be notified by CapStar of the new index prior to the transition.
If you have a LIBOR-based loan or line at CapStar that renews after December 15, 2021 though before June 30, 2023, we will work with you at that time to incorporate an appropriate replacement index.
CapStar will keep you apprised of any action required on your part.
Where can I find additional information about the LIBOR transition?
Listed below are various resources with additional information regarding the transition from LIBOR.
Alternative Reference Rates Committee (ARRC)
TRANSITION FROM LIBOR
The Future of LIBOR
Future cessation and loss representativeness of LIBOR benchmarks (PDF)
Announcements on the end of LIBOR
CME Group Benchmark Administration
CME SOFR TERM RATES AND DATA
Federal Reserve Bank of New York
Reference Rates - FEDERAL RESERVE BANK of NEW YORK (newyorkfed.org)
What if I have more questions about LIBOR or SOFR?
You may contact your CapStar Relationship Manager for additional guidance regarding the transition.
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