The global financial industry is preparing to transition away from the use of the London Interbank Offered Rate (LIBOR). As such, Pacific Premier Bank is committed to keeping its clients informed as to how the transition from LIBOR may impact you.
What is LIBOR?
The London Interbank Offered Rate or LIBOR is a popular benchmark interest rate index. Banks worldwide use LIBOR to price a wide range of financial products, including commercial and consumer loans, swaps, derivatives, and other securities. LIBOR is published each day by the Intercontinental Exchange (ICE) and is administered by the ICE Benchmark Administration (IBA).
Why is LIBOR going away?
LIBOR is being discontinued because, over time, the underlying market that determines LIBOR has seen a significant decrease in the number of actual transactions upon which the rate is based. This means LIBOR is often based on the judgment of a panel of banks rather than on robust market data, making the index less reliable and credible. There are also concerns about the validity and transparency of LIBOR. As a result, the IBA is taking steps to phase out LIBOR over the next couple of years, and the global financial industry is seeking a LIBOR alternative.
Key LIBOR Dates:
The first key LIBOR date was December 31, 2021, which was the final publication date for the 1-week and 2-month tenors of USD LIBOR. December 31, 2021 was also the date by which federal regulators, including the Federal Reserve Board, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency, advised banks to cease entering into new contracts that use USD LIBOR as a reference rate.
The second key LIBOR date is June 30, 2023, which is the final publication date for the remaining and most commonly used USD LIBOR tenors, including the overnight, 1-month, 3-month, 6-month, and 12-month indices.
What will replace LIBOR?
A number of potential alternate reference rates have been proposed to replace LIBOR.
In 2017, the Alternative Reference Rates Committee (ARRC), composed of a diverse group of financial market participants and convened by the Federal Reserve Board and the Federal Reserve Bank of New York, identified the Secured Overnight Financing Rate (SOFR) as the recommended alternative to USD LIBOR. On July 29, 2021, ARRC formally recommended the CME Group’s forward-looking SOFR term rate (Term SOFR) as the replacement rate for LIBOR tenors other than overnight.
Additionally, the Adjustable Interest Rate (LIBOR) Act was signed into law by President Biden on March 15, 2022 and identifies SOFR as the selected benchmark replacement index by the Federal Reserve Board.
Has Pacific Premier selected a replacement index yet?
Yes, Pacific Premier has selected SOFR as the replacement index for existing loans that have LIBOR as an index. However, for new loans, Pacific Premier will continue utilizing several different indices for its various loan products.
What is SOFR?
SOFR is a fully-transaction based, nearly risk-free reference rate. It is derived from transactions in the U.S. Treasury repurchase, or repo, market, and represents a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities. SOFR is published daily by the Federal Reserve Bank of New York. Since SOFR was first published in April 2018, daily transaction volume underlying SOFR has averaged more than $980 billion, evidencing a deep and robust market supporting the index. (ARRC FAQ Version: August 27, 2021)
How is SOFR different from LIBOR?
Although LIBOR and SOFR reflect short-term borrowing costs, they are calculated very differently, as reflected in the table below:
|Bank-to-bank lending rate (includes credit risk)||Risk-free rates (does not include credit risk*)|
|Unsecured||Secured (with U.S. Treasuries)|
|Based on bank submissions incorporating a limited number of actual transactions and expert judgment||Transaction based|
|$500 million of daily trading of actual transactions in the 3-month wholesale funding market||$1 trillion of daily trading of actual transactions in the overnight Repo market|
|Forward-looking term structure||
|USD, GPB, EUR, JPY and CHF currency options||USD only currency option|
*Because SOFR is fundamentally different than LIBOR, using SOFR requires a spread adjustment. The spread adjustment will reflect and account for the historical differences between LIBOR and SOFR in order to make the spread-adjusted rate comparable to LIBOR in a fair and reasonable way, thereby minimizing the impact to borrowers and lenders. (ARRC FAQ Version: August 27, 2021)
Is there any Federal legislation regarding the LIBOR transition?
Yes. The Adjustable Interest Rate (LIBOR) Act (the “Act”), included as part of H.R. 2471, was signed into law on March 15, 2022, and provides a basic framework for addressing the discontinuation of LIBOR as of June 30, 2023 under federal law. Two of the main purposes stated in the Act are (i) to establish a clear and uniform process, on a nationwide basis, for replacing LIBOR in existing contracts the terms of which do not provide for the use of a clearly defined or practicable replacement benchmark rate, without affecting the ability of parties to use any appropriate benchmark rate in new contracts, and (ii) to preclude litigation related to existing contracts the terms of which do not provide for the use of a clearly defined or practicable replacement benchmark rate. The Federal Reserve Board identified SOFR as the “Board-selected benchmark replacement.” The Act also fixes the “tenor spread adjustment” for non-consumer loans as A) 0.00644 percent for overnight Libor; B) 0.11448 percent for one-month Libor; C) 0.26161 percent for three-month Libor; D) 0.42826 percent for six-month Libor; and E) 0.71513 percent for 12-month Libor, which tenor spread adjustments are based on historical 5-year median spreads between USD LIBOR and compound averages of SOFR.
How will Pacific Premier Bank products be impacted?
As of December 31, 2021, Pacific Premier ceased offering LIBOR as a pricing benchmark for any new contracts, including loan originations, loan renewals, and maturity extensions. Existing contracts and documentation for loans and loans tied to a back-to-back swap that do not have fallback language* may need to be amended to include fallback language, or will need to be transitioned from LIBOR to an alternative reference rate when LIBOR is discontinued, non-representative, or unavailable.
* Fallback language refers to the legal provisions in a contract that define the process through which a replacement rate can be identified if the underlying reference rate in the product (e.g. LIBOR) is discontinued, non-representative, or unavailable. (ARRC FAQ Version: August 27, 2021)
What is Pacific Premier doing for the LIBOR transition?
Established a LIBOR Transition Working Group:
To manage the transition for our clients and provide oversight for Pacific Premier, we established a LIBOR Transition Working Group in March 2019. The Working Group consists of members of executive management, plus subject matter experts from across the Bank’s departments. The working group is focused on ensuring that Pacific Premier is well positioned to deliver a smooth transition process for our clients.
Providing Client Education:
It is important that all of our clients understand this global market change and its impacts. We will make our best effort to provide helpful information and resources, and to communicate directly to our clients about the transition, listening to concerns. As the transition evolves and we develop more specific guidelines and protocols for contracts and product offerings, we will continue to update our clients.
Implemented New Fallback Language in Contracts:Beginning June 2019, Pacific Premier started including robust fallback language in all new loan documents and loan modification agreements for loans with LIBOR as the underlying index. Fallback language refers to the legal provisions in a contract that define the process through which a replacement rate can be identified if the underlying reference rate in the product (e.g. LIBOR) is discontinued, non-representative, or unavailable. (ARRC FAQ Version: August 27, 2021)
Helpful Links / Resources
- Alternative Reference Rates Committee (ARRC) in the United States
- ARRC FAQ
- International Swaps and Derivatives Association (ISDA): Benchmark Reform and Transition From LIBOR
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