The Final Countdown: Most Libor-Transition Issues Resolved, But Trillions In Loans Still In Limbo
Their message? Time is running out to smoothly and safely transition legacy financial instruments to the Federal Reserve Secured Overnight Funding Rate, or any other alternative rate-setting mechanism, as published Libor rates go away completely in the coming two years.
Libor, which is the lending rate between banks, has served as the baseline for setting short-term interest rates since the 1980s, according to JPMorgan. The benchmark is used in many commercial real estate adjustable-rate and floating-rate loans and residential loans, with term sheets for bonds, construction loans and other CRE financial instruments setting a certain percentage above Libor.
While a few other rate-setting alternatives are available, the Secured Overnight Funding Rate, or SOFR, is expected to mostly fill the void in rate-setting left by Libor when the first of the rates tied to it expire at the end of this year.
Randal Quarles, vice chair for Supervision at the Fed and chair of the Financial Stability Board, warned during a webcast hosted by the Treasury Department's Financial Stability Oversight Council on Friday that with the first Libor deadline just months away, some financial institutions are still lagging way behind in getting ready for the transition.
"Despite all of these years of work to transition away from Libor, despite Libor's record manipulation and despite the clear and unalterable intention of the ... banks to stop participating in the production of Libor, some market participants seem to believe that the remorseless evolution of the universe will somehow not involve them," Quarles said. "Others have adopted a posture of strategic procrastination, watching as others take the necessary steps to prepare for the imminent end of Libor."
Lawmakers in Washington, D.C., proposed bipartisan legislation in April to create a streamlined plan for dealing with any legacy financial contracts linked to Libor rates that could falter as the final deadlines approach. Two of the minor London Interbank rates will no longer be published as of January, and by June 2023, none of the London Interbank rates will be published.
While 99% of the $200 trillion in affected business loans, home mortgages and other instruments that have adjustable-interest rates have been resolved to deal with the Libor transition, Democratic Rep. Brad Sherman, who represents California, warned in a House committee hearing last month that 1% of the impacted instruments, or roughly $2 trillion worth, are still in some state of uncertainty, particularly until streamlined federal regulation is in place to deal with them.
"I don't want to minimize this. This is still $2 trillion, and Jerome Powell of the Fed has told us that this is a systemic risk to our entire economy," Sherman said during the public hearing.
The CRE capital markets and related contracts are definitely not immune, said Paul Forrester, a partner with Mayer Brown’s Banking & Finance practice.
"Within that $2 trillion estimate, I suspect there is a significant number of commercial real estate loans. People rate longer-term mortgages and financing for real estate for the risk of that category of contracts having maturity dates well beyond the current termination dates," Forrester said. "There are probably a good number of them that won't have fallbacks."