LIBOR Transition: Frequently Asked Questions
Why is LIBOR being phased out?
LIBOR is an interbank offered rate (IBOR) being phased out as part of a globally coordinated effort to identify new benchmark interest rates that could serve as an alternative to their LIBOR counterparts for certain major currencies (e.g., USD, GBP and JPY).
Traditionally, the LIBOR index was based on actual bank-to-bank lending transactions, but changes in certain laws led to a significant change in how banks fund themselves, including a reduction in short-term funding through the unsecured bank-to-bank transaction marketplace.
In the past decade, with too few actual bank-to-bank transactions to determine a LIBOR rate based entirely on actual transaction data, LIBOR had become susceptible to manipulation, which resulted in lawsuits.
Recognizing the potential global impact, an intergovernmental forum of 19 countries plus the European Union called the G-20 asked its Financial Stability Board (FSB) to undertake a fundamental review of major interest rate benchmarks and plans for reform.
In response, the Federal Reserve Board and Federal Reserve Bank of New York convened the Alternative Reference Rates Committee (ARRC) in 2014 and began meeting with market participants to identify an alternative reference rate to USD LIBOR. The ARRC is a group of public and private market participants convened to recommend replacements for USD LIBOR. The ARRC ultimately identified the Secured Overnight Financing Rate (SOFR) as its recommended replacement rate.
The following sources contain additional information on this topic:
- The ARRC: https://www.newyorkfed.org/arrc
- The Council on Foreign Relations: https://www.cfr.org/backgrounder/understanding-libor-scandal
- The International Swaps and Derivatives Association, Inc.: https://www.isda.org/2022/05/16/benchmark-reform-and-transition-from-libor/
- The Consumer Financial Protection Bureau (“CFPB”): https://www.consumerfinance.gov/compliance/compliance-resources/other-applicable-requirements/libor-index-transition/libor-transition-faqs/
How do I know if I have a loan tied to LIBOR?
Your loan documents will specify LIBOR as the benchmark that is used to calculate interest on your loan.
When will LIBOR end?
The one-week and two-month USD LIBOR rates ceased being published after December 31, 2021, along with other LIBOR rates for non-USD currencies.
The other USD LIBOR rates continued to be published after December 2021 for use in financial contracts. However, in anticipation of the future cessation of LIBOR, including USD LIBOR rates, Pinnacle stopped originating new loans and lines of credit tied to any LIBOR rate on December 31, 2021.
The remainder of the USD LIBOR rates—including the most popular, the one-month and three-month rates—will not be available for use by Pinnacle after June 30, 2023.
What does this mean for me?
If you have a LIBOR-based loan or line of credit that matures ON OR BEFORE June 30, 2023, then there will be no impact on your loan.
If you have a LIBOR-based loan or line of credit and such credit facility matures AFTER June 30, 2023, then LIBOR’s unavailability means that your loan or line of credit will transition to a new interest rate benchmark. If your loan or line of credit is with Pinnacle, the new benchmark to determine your overall interest rate will be:
- The specific replacement benchmark rate agreed to in your loan documents; OR
- A combination of (1) a benchmark replacement based on SOFR and (2) a “Credit Spread Adjustment,” in accordance with the Adjustable Interest Rate Act (LIBOR Act)
What is SOFR? What is Term SOFR?
SOFR is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities. Each business day, the Federal Reserve Bank of New York (FRBNY) publishes the SOFR on the FRBNY website at approximately 8:00 a.m. ET.
How is it different from LIBOR?
LIBOR is a forward-looking term rate used to indicate an interest rate for borrowing money into the future (e.g., one month, three months, six months).
SOFR provides a rate indicative of the cost to borrow cash on a “risk free” basis for one night – the prior night.
Therefore, the CME Group Benchmark Administration Limited (CME), which publishes SOFR, had to launch forward-looking tenors of SOFR. They now publish one-month, three-month, six-month and one-year “Term SOFR.” These are the recommended and endorsed by the ARRC and US regulators as replacements for LIBOR in business loan agreements.
What is the credit spread adjustment?
The Credit Spread Adjustment is a value added to Term SOFR to calculate the new “all-in” interest rate for loans and lines of credit transitioning from LIBOR to SOFR pursuant to the LIBOR Act, ARRC conventions and the CFPB’s Regulation Z or which are otherwise based on ARRC’s conventions. The Credit Spread Adjustment for your loan or line of credit will be based on the tenor of LIBOR being replaced.
More information regarding the credit spread adjustment, including the relevant values, is available in the public domain, including:
Why is there a credit spread adjustment?
LIBOR is a rate meant to represent a bank’s cost of funding based on loans between banks, and therefore LIBOR is a value that represents some credit risk. In comparison, Term SOFR is derived from transaction data which is generally described as being without credit risk or a “risk-free” rate. As a result, SOFR is generally less than LIBOR. The addition of the Credit Spread Adjustment is intended to account for the historical difference between LIBOR and SOFR and mitigate any economic gains or losses due solely to the transition from LIBOR to Term SOFR.
How is the new overall rate calculated?
Currently, for your LIBOR payments, your total interest payments are based on a combination of (1) a LIBOR interest rate (e.g., one-, three-, six- or 12-month LIBOR), plus (2) a margin or spread. These specific values for your credit facility are specified in your loan documents signed at their closing (subject to modifications following any subsequent amendments).
The transition from LIBOR to Term SOFR will not change the agreed to margin or spread. However, when referencing your new SOFR-based rate, your overall rate will be based on a combination of (1) the replacement Term SOFR rate, plus (2) the credit spread adjustment, plus (3) your original margin or spread
As noted above, the value of the credit spread adjustment is available from various public sources.
What about consumer loans?
Consumer loans will also utilize CME’s Term SOFR, but the rate will be published by Refinitiv as the all-in rate of CME’s Term SOFR plus the credit spread adjustment. For more about consumer loans and lines of credit, see explanations on the Consumer Financial Protection Bureau website and Refinitiv’s website.
What should I do if I have a loan tied to LIBOR?
No action is required on your part to transition your loan from LIBOR to a SOFR-based benchmark.
The changes here are complicated, and this FAQ cannot provide answers unique to your specific situation. If you have any concerns about LIBOR exposure to Pinnacle and the benchmark change, reach out to your personal financial and legal advisors.
This FAQ does not provide any legal, financial, accounting, tax, or investment advice upon which you should rely to make decisions. We cannot provide any assurances as to the consequences, or likely costs or expenses associated with any of the changes arising from the matters discussed in this FAQ, though they may be important to you.
Please note that there could be changes to the LIBOR transition timeline noted herein or applicable law and that, as a result, the information contained in this notice is subject to change.
