Regulators say banks can price loans using any appropriate reference rate as they prepare for Libor’s end.
You may possibly have missed a development that happened three days after the presidential election: US banking regulators gave banks more confidence they can decide to use Libor-replacement rates other than the secured overnight financing rate (SOFR), which the Federal Reserve has endorsed but that some regional banks view as problematic.
- “Examiners will not criticize banks solely for using a reference rate, including a credit-sensitive rate, other than SOFR for loans,” guidance from the Fed, the FDIC and the Office of the Comptroller of the Currency stated.
It’s OK to be different. The guidance bolsters Fed Chair Jerome Powell’s May statement recognizing Ameribor, an alternative to Libor published by the American Financial Exchange (AFX), as a “fully appropriate” alternative for banks.
- “This is another step on the march toward the legitimacy of alternative benchmarks and for the market to decide what the replacements for Libor will be,” said Reed Whitman, treasurer at Brookline Bancorp.
- He added that this gives more confidence that “products we develop tied to a non-SOFR rate will be accepted; it’s an additional accelerant.”
- If regulators had warned banks against “using a different benchmark, that effectively would have shut down alternatives.” said Alexey Surkov, a partner with Deloitte Risk and Financial Advisory and a co-chair of a working group under the Alternative Rates Reference Committee (ARRC), a private group convened by the Fed to help guide the Libor transition.
The regional view. Regional banks have concerns about pricing their floating-rate products and funding over SOFR, based on the secured overnight repurchase agreement (repo) market, because it does not reflect their cost of funds.
- Ameribor is instead generated from the rates at which financial institutions lend to one another over the AFX, an exchange launched in 2015 by Richard Sandor, an innovator in the futures market.
- In an interview with NeuGroup Insights, Mr. Sandor called the guidance a “big step forward” since now all the banking regulators are “opining together.” He added that for those who thought Libor might sustain itself, “this is another nail in the coffin.”
Alternatives. Some institutions have considered the prime rate and Fed Funds as Libor alternatives, at least until transaction-based benchmarks become sufficiently robust.
- Some bank products currently reference those rates, Mr. Surkov said, and lenders may choose to stick with them. Credit cards, for example, often reference prime.
- Similarly, mortgages priced over Libor are widely expected to transition to SOFR, but adjustable rate mortgages (ARMs) based on Constant Maturity Treasury (CMT) rates have existed for a long time, he said, and may very well continue.
- Mr. Whitman said he foresees a combination of benchmarks, including SOFR, Ameribor and perhaps other indices that will be “repurposed for specific uses.”
Good timing. The ARRC recommends ceasing to use Libor to price floating rate notes by year-end and business loans and structured products by June 30, 2021.
- “So this helps ready us for the next phase of the transition, where banks stop booking Libor deals and start booking SOFR or Ameribor deals,” Mr. Whitman said.
