LOIS WEISS: A Banking Rule Change Puts $350 Trillion Of Debt In Limbo
A widely used index used to calculate floating interest rates that affects $350 trillion in global deals is being dumped at the end of 2021. It is leaving lenders and borrowers in a quandary to not only identify and agree on replacements, but also determine how to handle ongoing loans as well as the future wording of new loan documents.
“It’s going to be the lawyer employment act of 2018 and 2019,” said David Eyzenberg of his eponymous investment banking firm Eyzenberg & Co., who secures mortgages for clients. “There will be a fundamental shift.”
In June, a committee of 15 U.S. banks said it would replace its use of the London Interbank Offer Rate, known as Libor, with a new rate that would reflect the cost of borrowing cash secured against U.S. Treasurys debt. The Federal Reserve Bank of New York has proposed publishing this index in cooperation with the Office of Financial Research, but its timing is unclear. It could begin in early 2018 or significantly later.
In the U.S., almost every large floating loan from an insurance company, bank or conduit is tagged to Libor. The change affects almost every loan from real estate to credit card rates, student loans and car loans.
While many of these loans run for just five years, and would end before Libor is completely terminated, Eyzenberg wonders how to decide what is good for his clients who now need loans that will end or refinance after Libor dies.
The Alternative Reference Rates Committee was formed in 2014 to find an alternative to Libor, which was rocked by a scandal in 2008, when it was found the banks that set it manipulated it to make it seem like they were more financially healthy.
Since then, numerous global banks have been fined over $9B due to their involvement. Several bankers were jailed and others committed suicide. In 2014, the British Financial Conduct Authority transferred Libor’s administration to the Intercontinental Exchange Benchmark Administration Ltd., or ICE.
The ICE Libor now consists of 35 rates each day, covering five currencies for terms ranging from overnight to 12 months. But it is still based on estimates provided by bankers as to what they would charge for unsecured loans and, with few trades in certain currencies, the lenders that made up the committee agreed it has become unreliable.
Switzerland is already changing to a different benchmark at the end of this year, and on Thursday, the head of the FCA announced in London that it would end support for Libor four and a half years from now.
“We all thought it could happen, and now it will happen,” said Joshua Stein, an attorney who represents clients in commercial real estate financing and leasing transactions.
Many 10-year loans are fixed for a period of around seven years, and then switch to a rate over Libor for the remaining time. This provides opportunities for refinancing, a large lease rollover or the sale of the property, Eyzenberg said. But the change is throwing these new loans into a financial gray area.
“Some loans are drafted to say if Libor is not available, then a mutually agreed rate will be chosen,” Eyzenberg said. Other loans state if Libor is not around or can’t be determined, there will be another rate chosen by the lender. “It’s problematic, as it puts the borrower at their mercy."
Even Chatham Financial, which oversees swaps and derivatives around the globe, is trying to keep a perspective for its clients.
“Clearly, given the wide variety of language that can potentially appear in a loan agreement, any broad example will not be relevant for all circumstances,” its July 28 advisory, “Life after Libor: the $350 trillion question,” warns. “For new contracts, we would recommend working with your advisors to craft language that contemplates the eventual shift away from LIBOR.”
If all of this makes your head swim, and all you want to do is figure out what you will be paying, you are not alone.
The ARRC is still studying various rates and indexes and how they have correlated to Libor in the past, especially with regards to the “repo” or repurchase rates charged to banks by the central bank for short-term borrowing against securities.
At a presentation to the ARRC committee on Aug. 1, the committee showed graphs that took its proposed broad Treasurys repo rate (BTRR) and shadowed other indexes. The graphs showed the BTRR typically fell between the General Collateral i.e. GC rates, such as BNY Mellon’s Treasury Tri-Party Rate and the DTCC GCF Repo Rate.
There are also questions of whether the non-financial corporations need a rate that includes bank credit risk to help hedge their own cost of securing funding.
“Now we are in the forward-looking implementation phase and how we get from here to there," said Andrew Gray, a spokesman for the ARRC. "The ARRC is taking feedback on that.”
Chatham noted that after the Libor announcement, “Markets remained open and liquid. There has been no discernible impact on liquidity since the headlines came out, including derivatives priced off Libor that mature beyond 2021.”
“It will be just like Y2K," Stein said. "There was plenty of time to prepare and people paid attention and the problems that could have happened didn’t. It could have been a disaster and it wasn’t. This will be the same.”
Lois Weiss is a Bisnow featured columnist as well as a real estate reporter for the New York Post. She has covered New York City real estate for more than two decades and is a past president of the National Association of Real Estate Editors.