LIBOR Transition
The London Interbank Offered Rate (“LIBOR”), currently the world’s prevailing reference rate for financial instruments, will no longer exist after June 30, 2023. Farmer Mac is actively monitoring the LIBOR transition and is participating in numerous industry-wide and regulatory advisory committees in order to prepare for the transition to alternative reference rates. As part of our preparations, we are sharing the following answers to some of the most frequently asked questions about LIBOR.
LIBOR Frequently Asked Questions
What is LIBOR?
Many loans and financial derivatives have interest rates that are linked to a market-based interest rate, referred to as a reference rate. The London Interbank Offered Rate (“LIBOR”) is a reference rate used to indicate the estimated cost at which certain large, global financial lending institutions (“Contributor Banks”) can obtain unsecured funding for seven different tenors (overnight, one week, one month, two months, three months, six months, and 12 months) and for five different currencies (USD, GDP, EUR, CHF, and JPY). LIBOR rates are determined by an administrator, currently the ICE Benchmark Administration (“IBA”), based on information provided by each Contributor Bank.
How is LIBOR used?
LIBOR is the world’s prevailing reference rate for financial instruments, used particularly in the United States for a wide variety of products, including variable rate loans, interest rate derivatives, and securities. As of 2016, it was estimated that nearly $200 trillion of U.S. dollar financial contracts were indexed to LIBOR globally. Many variable rate loans, including loans in the sectors that Farmer Mac serves, currently use LIBOR as a reference rate.
The breakdown of the $200 trillion of U.S. dollar financial contracts indexed to LIBOR:
Source: 2016, Federal Reserve Bank of New York
What is happening with LIBOR?
Domestic and international bank regulators have expressed concerns about LIBOR, particularly the accuracy and legitimacy of the LIBOR reference rates quoted by each Contributor Bank. The decline in the number of Contributor Banks combined with the decline in inter-bank lending and a lack of transparency in determining the reference rate has created pressure to identify and transition to an alternative reference rate for financial instruments indexed to LIBOR.
The primary regulator of many LIBOR Contributor Banks, United Kingdom’s Financial Conduct Authority, announced all sterling, euro, Swiss franc, and Japanese yen, and the 1-week and 2-month U.S. dollar LIBOR settings will cease after December 31, 2021. The remaining U.S. dollar LIBOR settings will cease after June 30, 2023.
The Office of the Comptroller of the Currency, the Federal Reserve, and Federal Deposit Insurance Corporation issued a joint statement that no new contracts should reference LIBOR after December 31, 2021.
What will ultimately come to “replace” LIBOR in the capital markets?
In the U.S., the Federal Reserve created the Alternative Reference Rates Committee (“ARRC”), which was tasked with identifying potential alternative reference rates to LIBOR. The ARRC recommended the creation and implementation of the Secured Overnight Financing Rate (“SOFR”) as a replacement reference rate for LIBOR, primarily for U.S. dollar transactions. SOFR is a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities. The Federal Reserve first published the overnight SOFR rate in April 2018.
While the ARRC has endorsed SOFR as the preferred reference rate to replace LIBOR in the U.S., there are additional index rates currently being offered or considered by other financial lending intuitions, including U.S. Prime Rate, AMERIBOR, and Constant Maturity Treasuries (“CMT”).
What is Farmer Mac doing to monitor and address the future of LIBOR?
Farmer Mac is actively monitoring the current state and future of LIBOR and is participating in numerous industry-wide and regulatory advisory committees, including as members of the ARRC and its working groups.
In 2019, Farmer Mac elected to introduce Variable Rate Mortgage (“VRM”) loan products to serve as an alternative to LIBOR-based products. Farmer Mac began phasing out our LIBOR-based products at the same time, and as of July 2020, we will no longer offer products indexed to LIBOR. The interest rates for our VRM products are determined by Farmer Mac, and they are published daily on our customer portal at eFarmerMac.com.
Farmer Mac will continue to monitor available market-based reference rates and the ARRC recommendations and may consider modifying our product offerings as more information becomes available.
Farmer Mac customers can learn more about our VRM products by visiting the “FAQs for Farm & Ranch Product Changes” within the Resource Library on the eFarmerMac.com customer portal.
What alternative products are available to Farmer Mac Approved Lenders?
In 2019, Farmer Mac elected to introduce Variable Rate Mortgage (“VRM”) loan products to serve as an alternative to LIBOR-based products. Farmer Mac began phasing out our LIBOR-based products at the same time, and as of July 2020, we no longer offer products indexed to LIBOR. The interest rates for our VRM products are determined by Farmer Mac, and they are published daily on our customer portal at eFarmerMac.com.
Farmer Mac will continue to monitor available market-based reference rates and the ARRC recommendations and may consider modifying our product offerings as more information becomes available.
Farmer Mac customers can learn more about our VRM products by visiting the “FAQs for Farm & Ranch Product Changes” within the Resource Library on the eFarmerMac.com customer portal.
What will happen to existing Farmer Mac loans that are indexed to LIBOR?
It is expected that LIBOR will continue to be used in the capital markets through 2021; however, all existing variable rate loans currently referencing LIBOR will be affected once LIBOR ends on June 30, 2023. Given the potential significance of this change, Farmer Mac is actively reviewing the latest developments now to help prepare ourselves, our customers, and their borrowers for a phase-out of LIBOR.
Farmer Mac relationship managers are proactively working with customers on a case-by-case basis to address this upcoming change. If you are a Farmer Mac Approved Lender, please contact your relationship manager or a client services specialist to discuss options and alternatives for new and existing loans.
How can market participants prepare for the transition?
The ARRC is leading the effort to prepare the markets for LIBOR’s transition, and market participants can act now to prepare for the transition. Initial actions that market participants can take are listed below:
- Continue to monitor the developments related to the LIBOR transition.
- Take inventory of current variable rate loans that use LIBOR as a reference rate and categorize those that are scheduled to mature, or that may otherwise terminate, before and after the start of LIBOR’s phase-out after 2021. For existing transactions that mature after December 31, 2021, consider converting the existing LIBOR reference rate to another index before that date; or, at a minimum, amend the loan documentation with market-based terms that outline what will happen in the event that LIBOR is phased out.
- Limit the origination of new LIBOR-indexed loans with maturities past December 31, 2021.
Farmer Mac is dedicated to helping lenders explore alternatives for their LIBOR-indexed loans. Taking action early provides lenders, and their borrowers, an easier LIBOR transition path through re-indexing or restructuring loans. Lenders may contact their relationship manager or a client services specialist to discuss options and alternatives for new and existing loans.
