Libor transition progresses, but hurdles remain for legacy loans

The banking industry’s transition away from the scandal-plagued Libor interest rate benchmark is largely proceeding smoothly, though many companies are still facing technical difficulties.

That’s according to a new survey from Bloomberg, which last month asked 130 lenders and corporate borrowers across the world about their progress in switching to alternative benchmarks. The London interbank offered rate — which used to be described as the world’s most important number — is being phased out globally after a rate-rigging scandal years ago.

Half of the survey’s respondents said they are still facing challenges in preparing their systems to transition older loans to non-Libor rates — a significant improvement from last summer, when 82% of respondents in a similar survey said they were facing operational hurdles.

Bloomberg

The survey “clearly shows that firms are moving off” U.S. dollar Libor products, said Steffan Tsilimos, Bloomberg’s global head of interest rate derivatives products. “But there's still quite a bit of work to do to ensure operational readiness for a smooth transition next year.”

The transition hit a major milestone at the start of this year with the implementation of new U.S. regulatory guidance. Under the guidance, U.S. banks may no longer make new Libor loans, but legacy contracts may still reference Libor until the benchmark’s publication stops in mid-2023.

Now the industry is focusing on transitioning existing Libor-linked loans to new benchmarks. Those efforts got a boost this week from a new federal law that provides a roadmap for legacy contracts that are harder to switch.

The remaining steps in the transition may fall more on borrowers than on banks. Banks have set up a range of services to assist customers, but some corporate borrowers may be a bit further behind in ensuring their internal systems can switch Libor contracts and payments to new rates, Tsilimos said.

Global companies that deal in multiple currencies have been making faster Libor transitions, he said. But smaller American companies that only deal in U.S. dollar Libor did not face the same “urgent need” to switch their legacy contracts onto new benchmarks, he said.

Nearly two-thirds of the survey respondents said they will continue working on the Libor transition in their loans this year and potentially in early 2023. Fifteen percent said their timelines for loan transitions were “undecided,” while just 9% said they have finished the process.

Though the Libor transition remains a work in progress, it has so far gone “more smoothly than I ever would have anticipated,” said Todd Cuppia, a managing director at the consulting firm Chatham Financial, who works with midsize banks.

The banking industry was initially slow to switch to non-Libor benchmarks in their loans, but activity ramped up at the close of 2021 as the year-end deadline for the implementation of the new regulatory guidance approached.

“It’s shocking to see how smoothly it’s all gone since the turn of the year,” Cuppia said, noting the “herculean nature” of moving the financial world away from a benchmark it’s relied upon for decades.

In the United States, the Secured Overnight Financing Rate, known as SOFR, appears to be the leading contender to replace Libor in most loans. Some banks are also using Bloomberg’s BSBY rate or Ameribor, a rate developed by the American Financial Exchange that certain midsize lenders prefer.

The Alternative Reference Rates Committee, a group of market participants convened by the Federal Reserve, selected SOFR as a Libor replacement in 2017.

Tom Wipf, a Morgan Stanley executive who chairs the committee, said the Libor transition has seen “considerable progress over the past few months,” pointing to the industry’s adoption of SOFR in new lending. The Bloomberg survey “shows that many banks are now turning to move their legacy loan books in the same direction,” Wipf said in a statement.

He also praised Congress for approving a Libor-related fix for so-called tough legacy contracts. Under the law signed this week by President Biden, banks and their clients can renegotiate existing Libor loans with any rate they deem appropriate, including non-SOFR alternatives. Contracts that cannot be renegotiated by the mid-2023 deadline will automatically transition to SOFR once Libor goes away.

“The new federal legislation will play a critical role in ensuring that market participants are able to manage the risk of outstanding Libor-based contracts,” Wipf said. “Congress has given us all the legal clarity needed to meet the impending end of Libor.”

At least so far, SOFR has a substantial lead over its competitors, though BSBY and Ameribor are being used in some loans. Loan data is sparse because many contracts aren’t publicly available, but analysts say that SOFR use ramped up late last year, and its edge has only grown since.

The leveraged loan market, where banks and investors partner on loans to riskier corporate borrowers, was initially slow to adopt SOFR. But since the start of 2022, some $89 billion worth of new SOFR loans have been issued, compared with only $10.5 billion in the last two months of 2021, according to S&P Global’s Leveraged Commentary & Data.

In a statement, American Financial Exchange Chairman and CEO Richard Sandor said early surveys of banks show Ameribor has been used in thousands of loans, whose values totaled between $10 billion and $20 billion. Individual loan amounts ranged from between $5 million to $250 million, and “customer awareness is growing,” Sandor said.

Bloomberg said in a statement that it is hard to quantify how many BSBY loans are being made, given that some banks use the rate for nonpublic loans. But the company flagged larger syndicated deals, such as a $150 million revolving loan to the retailer Duluth Holdings in May and a $2.3 billion loan in September to the trucking company Knight-Swift Transportation Holdings.