If you are a business owner and have a bank loan, you are likely familiar with the concept of LIBOR. Banks frequently use LIBOR (London Interbank Offered Rate) to calculate the interest rate on a variety of financial products including variable rate loans.
A borrower’s interest rate is often calculated based on a LIBOR-based index plus an applicable margin. For example, if the one-month LIBOR is 2.0% and the applicable margin is 1.5%, then the interest rate is 3.5%. It is estimated that close to $300 trillion in loans, derivatives and other financial contracts are based on LIBOR pricing. It is based on submissions from banks estimating the daily interest rate for each bank to borrow money from another bank. As a result, LIBOR can fluctuate as economic conditions change. In recent years, however, price-fixing scandals have undermined LIBOR into a questionable standard. As a result, the United Kingdom authority which oversees LIBOR has stated that reference banks will no longer be required to quote LIBOR by the end of 2021, and the future of LIBOR is now in doubt.
The proposed U.S. replacement for LIBOR is the Secured Overnight Financing Rate (SOFR). It is a broad Treasurys financing rate linked to the cost of borrowing cash secured against U.S. government debt. This rate is based on actual transactions so, in theory, is less subject to market manipulation. It remains to be seen how and when the banking industry will ultimately adopt SOFR. However, most banks are already figuring out how to best transition away from LIBOR in loan transactions.
What this means for you – Existing loan agreements maturing after December 31, 2021 will need to be reviewed to determine whether there is fallback language to choose a replacement rate in the event that LIBOR ceases to be published. Otherwise, loan agreements will need to be amended to provide for such event. New loan agreements that mature after December 31, 2021 will also need such fallback language to account for the transition away from LIBOR. Companies will need to discuss with their bank how interest will be calculated going forward and what impact, if any, the LIBOR phase-out will have on their business.
If you have any questions regarding LIBOR phase-out or need assistance in updating loan document provisions, please contact McCarty, Lebit, Crystal & Liffman’s Michael Makofsky, 216-696-1422, [email protected].
