Takeaways from the Crowe community bank survey on LIBOR transition

Background

In July 2017, the Financial Conduct Authority (FCA) announced that the availability and reliability of the London Interbank Offered Rate (LIBOR) beyond 2021 would not be guaranteed.¹ Subsequently, on March 5, 2021, the FCA announced that the publication of certain less commonly used tenors of U.S. dollar (USD) denominated LIBOR will cease immediately following the LIBOR publication on Dec. 31, 2021, and all other USD LIBOR settings will cease immediately following the LIBOR publication on June 30, 2023.²

In November 2020, the federal banking regulators released a “Statement on LIBOR Transition,”³ explaining that the June 30, 2023, cessation date “would allow most legacy USD LIBOR contracts to mature before LIBOR experiences disruptions.” The statement goes on to say, “the agencies believe entering into new contracts that use USD LIBOR as a reference rate after December 31, 2021, would create safety and soundness risks and will examine bank practices accordingly.”

With the Dec. 31, 2021, cessation date fast approaching and with the understanding that banking regulators are closely monitoring banks’ LIBOR transition activities, in July 2021 Crowe surveyed community banks to understand what products were most affected, what replacement rate(s) were being considered, and what transition activities institutions had completed.

A total of 75 institutions, each with total assets of less than $30 billion, responded to the survey. Exhibit 1 shows a summary of those institutions by asset size.

Exhibit 1: Survey respondents by asset size

Source: Crowe analysis

Instruments affected

Not surprisingly, loans were named as the most common instrument with LIBOR exposure, followed by derivatives, securities, and debt. Banks with greater than $10 billion in assets were more likely to have LIBOR exposure in their securities and derivatives (Exhibit 2). Survey respondents identified virtually no LIBOR exposure in employment or lease contracts.

Exhibit 2: Instruments with LIBOR exposure

Source: Crowe analysis

Replacement rates

Only half of the respondents said that their institution has selected a replacement rate or multiple replacement rates, with the other half saying their institution has not selected a replacement rate or they are unsure if a final selection had been made.

For loan contracts, more than half of respondents said they are considering using multiple replacement rates (see Exhibit 3). Among all respondents, the Secured Overnight Financing Rate (SOFR) has a significant edge, with three-fourths of the respondents considering SOFR. Prime was the second most considered replacement rate at 43% of respondents (notably 67% of respondents with total assets greater than $10 billion), followed by the American interbank offered rate (Ameribor) at 24% of respondents and the Bloomberg Short-Term Bank Yield Index (BSBY) at 19% of respondents (Exhibit 4).

Exhibit 3: Comparison of select rates included in survey

Rate	Ameribor	BSBY	Prime*	SOFR
Publisher	Cboe Global Markets Inc.	Bloomberg	Wall Street Journal	Federal Reserve Bank of New York
Basis	Based on overnight unsecured loans transacted on the American Financial Exchange LLC⁴	Seeks to measure the average yields at which large, global banks access USD senior unsecured marginal wholesale funding⁵	The base rate on corporate loans posted by at least 70% of the 10 largest U.S. banks⁶	Reflects the cost of overnight borrowing and lending in the U.S. Treasury repo market
Credit risk embedded?	Yes	Yes	Yes	No; it is a risk-free rate
Term availability	7, 30, and 90 days	1, 3, 6, and 12 months	No	Currently 1, 3, and 6 months**

* More than one variation of prime rate exists, and the survey did not specify a particular version. The version published by the Wall Street Journal is commonly used.
** On July 29, 2021, the Alternative Reference Rates Committee (ARRC) formally recommended Term SOFR, which will be administered by the CME Group, for use as a replacement rate.⁷ The “ARRC Best Practice Recommendations Related to Scope of Use of the Term Rate” specifically “supports the use of SOFR Term Rate in addition to other forms of SOFR for business loan activity” but “does not support the use of the SOFR Term Rate for the vast majority of the derivatives markets.”⁸

Source: Crowe analysis

Exhibit 4: Replacement rates for loans being considered by all respondents

Source: Crowe analysis

When considering only the responses of the 35 respondents that said that their institutions have decided on a replacement rate, the popularity of Ameribor and BSBY decline, particularly among institutions with greater than $10 billion in assets (Exhibit 5).

Exhibit 5: Alternative rates chosen by respondents who said that their institutions have selected a replacement rate or rates for the majority of their LIBOR exposure

Source: Crowe analysis

In his prepared remarks⁹ delivered June 11, 2021, before the Financial Stability Oversight Council (FSOC), Securities and Exchange Commission Chair Gary Gensler expressed his belief that BSBY as a potential replacement rate has several of the same flaws as LIBOR. “Both benchmarks are based upon unsecured, term, bank-to-bank lending. Term BSBY (1-, 3-, 6-, 12-month) is underpinned primarily by trades of commercial paper and certificates of deposit issued by 34 banks. For instance, the median trading volume behind three-month BSBY is single-digit billions of dollars per day. Median trading volumes for 6- and 12-month BSBY are even lower.”

At the same FSOC meeting, Randal Quarles, the vice chair for supervision of the Board of Governors of the Federal Reserve System, issued a more general warning to banks around selection of replacement rates. “Lenders and borrowers are free to choose the rate they wish to use to replace LIBOR on newly originated loans, but they should make that decision with a full understanding of … how their chosen reference rate is constructed, that they are aware of any fragilities associated with that rate and the markets that underlie it, and – most importantly – that they use strong fallback provisions.”¹⁰

LIBOR transition progress

Most survey respondents said their institutions have established a transition plan and identified their LIBOR exposure (Exhibit 6). While just over two-thirds of respondents’ institutions have added fallback language to their new contracts, only one-third have modified existing contracts to add fallback language. With the prevalence of one-month and three-month LIBOR observed in community bank contracts, it is likely that institutions are taking a phased approach to LIBOR – focusing on eliminating new LIBOR exposure by the end of the year to meet regulatory expectations and planning a shift to modifying existing LIBOR exposure during 2022.

Exhibit 6: LIBOR transition steps already completed

Source: Crowe analysis

Assessing the accounting implications of LIBOR transition is, not surprisingly, lagging behind all of the other transition-related activities, but institutions should take caution here. The optional transition accounting guidance in Accounting Standards Codification Topic 848 provides significant LIBOR transition relief when it comes to assessing the accounting and financial reporting implications of modifying contracts. However, this optional expedient generally must be elected on a class-of-instrument level (with the exception of hedging, which can be elected on an individual hedge basis), and the eligible modifications are those that only relate to the replacement of a reference rate. For example, making a change to the principal balance or maturity date of the loan while at the same time modifying the reference rate would preclude that modification from the optional accounting relief. Institutions should be aware of this relief and make informed decisions about whether or not to avail themselves of it. Find more information about the accounting aspects of the LIBOR transition in the Crowe webinar recording “LIBOR Is Going Away. Are You Prepared?”

No matter where you are in your LIBOR transition journey, Crowe specialists can help you prepare for the phase-out of LIBOR and explore your options.

Chris L. Moore

Partner, Accounting Advisory

+1 502 420 4429

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Mandi Simpson

Partner, Accounting Advisory & Finance Transformation Leader

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¹Andrew Bailey, “The Future of LIBOR,” Financial Conduct Authority, speech at Bloomberg London, July 27, 2017, https://www.fca.org.uk/news/speeches/the-future-of-libor
²“Announcements on the End of LIBOR,” Financial Conduct Authority news release, March 5, 2021, https://www.fca.org.uk/news/press-releases/announcements-end-libor
³“Statement on LIBOR Transition,” Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corp., and Office of the Comptroller of the Currency, Nov. 30, 2020, https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20201130a1.pdf
⁴“Ameribor Methodology,” American Financial Exchange, accessed Aug. 12, 2021, https://ameribor.net
⁵“Introducing the Bloomberg Short-Term Bank Yield Index (BSBY),” Bloomberg Professional Services white paper, Dec. 18, 2020, https://www.bloomberg.com/professional/introducing-the-bloomberg-short-term-bank-yield-index-bsby/
⁶“WSJ Markets,” https://www.wsj.com/market-data/bonds/moneyrates
⁷“ARRC Formally Recommends Term SOFR,” Alternative Reference Rates Committee news release, July 29, 2021, https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2021/ARRC_Press_Release_Term_SOFR.pdf
⁸“ARRC Best Practice Recommendations Related to Scope of Use of the Term Rate,” Alternative Reference Rates Committee,” accessed Aug. 12, 2021, https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2021/ARRC_Scope_of_Use.pdf
⁹Gary Gensler, “Prepared Remarks Before the Financial Stability Oversight Council: LIBOR Statement,” U.S. Securities and Exchange Commission public statement, June 11, 2021, https://www.sec.gov/news/public-statement/gensler-fsoc-libor-2021-06-11
¹⁰Randal K. Quarles, presentation at the Financial Stability Oversight Council meeting, June 11, 2021, https://www.federalreserve.gov/supervisionreg/files/quarles-libor-presentation-20210611.pdf