The Shift From LIBOR to SOFR: What You Need to Know
Financial institutions worldwide, including Enterprise Bank & Trust, are preparing for the phaseout of the London Interbank Offered Rate (LIBOR), the most commonly used benchmark for lending. While this shift away from LIBOR impacts only a small percentage of Enterprise loan clients, it is important to understand the timing and potential impact of this shift. Regulatory guidance requires banks to shift existing LIBOR loans to other indexes by June 30, 2023.
LIBOR is the benchmark rate that banks pay to borrow from each other on an unsecured basis. That rate is set by a panel of banks that estimate what they would charge other banks for short-term loans. These loans can include mortgages, credit cards, and other financial products. Loan rates for borrowers can increase or decrease as LIBOR fluctuates.
Why The Shift Away From LIBOR?
For over 40 years, LIBOR has played a significant role in the worldwide financial services industry. However, an ongoing slowdown in the unsecured bank debt market has diluted LIBOR’s relevance. Following the 2008 financial crisis, the integrity of LIBOR was questioned. In the years since, alternatives have been explored for a more reliable rate that would more accurately reflect market conditions. This led U.S. regulators to issue guidance to financial institutions to discontinue using LIBOR.
What Benchmark Will Enterprise Use Moving Forward?
Based on the recommendation by the financial industry group, Alternative Reference Rate Committee (ARRC), Enterprise will use the Secured Overnight Financing Rate, or SOFR, for most U.S. dollar-denominated, LIBOR-based loans and derivatives. We will make this change no later than June 30, 2023. SOFR, which is published around 8 a.m. daily by the New York Federal Reserve Bank, is based on transactions in the U.S. Treasury repurchase market and is seen as preferable to LIBOR since it is based on data from observable transactions rather than on estimated borrowing rates. The ARRC was convened by the Federal Reserve Board and the New York Fed to facilitate the LIBOR transition. The ARRC is made up of a cross-section of accounting firms, legal firms, banks, and other industry representatives.
While LIBOR is based on bank credit risk submitted by a panel of banks, SOFR is a risk-free rate based on banks’ cost of borrowing. Accordingly, LIBOR is generally higher than SOFR. Due to this difference, a margin adjustment is needed to make SOFR-based loans more economically equivalent to LIBOR-based loans.
How Will This Impact Me?
If your financial product did not reference LIBOR, there is nothing you need to do. If your loan referenced the LIBOR rate (which also applies to some Enterprise clients with adjustable rate mortgages), you will receive correspondence from us letting you know in advance of the actual transition. That correspondence will include additional details and next steps. A copy of this notice will be provided to your Enterprise Relationship Manager as well.
The replacement of LIBOR will not change other terms of our loans, such as the maximum interest rate paid during the term of the loan or the timing of any interest rate resets.
The following links provide more information on the discontinuation of LIBOR.
- Alternative Reference Rates Committee website is maintained by the Federal Reserve Bank of New York and is available at: https://www.newyorkfed.org/arrc.
- The Federal Reserve website provides background information on the transition from LIBOR to SOFR at: https://www.federalreserve.gov/supervisionreg/libor-transition.htm.
- The International Swaps and Derivatives Association website has a repository for information relating to financial benchmark reform and the transition from LIBOR at: https://www.isda.org/2022/05/16/benchmark-reform-and-transition-from-libor/.