LIBOR/SOFR UPDATE

FEBRUARY 2020
 LIBOR/SOFR UPDATE – FEBRUARY 2020

TRA KELLY, DIRECTOR

Introduction
As the planned discontinuation of LIBOR and We also saw a strong surge of floating rate notes tied to
implementation of risk-free rates (RFR) is less than 2 SOFR in 2019, predominately from GSE (Fannie Mae and
years away, market participants are seeking greater Freddie Mac) and major banks. In total, more than 300
clarity on what the transition will look like, how the notes were issued, totaling about $275B.
new index will be calculated, what potential effects it
The ARRC has published formal Fallback Language
will have on their loans/hedges, etc. While progress still
options (ARRC Recommendations) for various cash
needs to be made, relevant regulators around the world
products: floating rate notes, bilateral business
have been working with policymakers and private-
loans, securitizations, adjustable rate mortgages,
market participants to continue refining the details for
and syndicated loans. While efforts were made for
the transition.
consistent Fallback Language across the product types,
The Federal Reserve Board and the Federal Reserve given the unique characteristics of each product some
Bank of New York formed the Alternative Reference customization was required.
Rates Committee (ARRC) in 2014 to head the transition
Implementation of the ARRC’s Recommendations has
from USD LIBOR. The ARRC also actively engaged in
been slow by market participants, as discussions
work led by the International Swaps and Derivatives
continue on the advantages and disadvantages to the
Association (ISDA) to determine appropriate fallback
SOFR variants. While the current situation is in flux, we
language for derivative contracts. The ARRC selected the
expect significant developments in 2020.
Secured Overnight Financing Rate (SOFR) in 2017 as the
appropriate replacement index and the New York Fed The focus of this update is for borrowers who finance
began publishing SOFR in April 2018. SOFR is based on with floating rate loans (bilateral business loans).
transactions in the overnight repurchase markets (repo), Especially significant for hedged loans, as we will focus
which averages roughly $1 trillion of transactions every on the ARRC’s recommended “Hedged Loan Approach”
day. The massive size of the underlying market makes Fallback Language.
SOFR a transaction-based rate, better reflecting current
financing cost.
 LIBOR/SOFR UPDATE – FEBRUARY 2020

TRA KELLY, DIRECTOR

Brief Background
LIBOR was originally based on interbank lending transactions, but due to changes in how banks fund themselves the
underlying bank-to-bank lending market has shrunk significantly. With few, if any, actual transactions for banks to base
their quotes on, LIBOR submissions became dependent on the panel banks’ own judgement. This led to an increase in
fraud and manipulation (LIBOR rigging scandals) for an index that is tied to almost $200 trillion in financial products
around the world.

Regulators globally have been actively investigating alternative risk-free rates (RFR) that are based on a larger pool of
underlying transactions. To help spur the market into action, in July 2017 the UK Financial Conduct Authority announced
it would no longer compel panel banks to submit LIBOR quotes after 2021.

Without a mandate to make submissions, banks may elect to no longer provide quotes given the risk and liabilities
(including fines) associated with quoting a rate that is lacking depth of reference transactions. Any subsequent LIBOR
fixings after 2021, even with the involvement of the current LIBOR administer, ICE Benchmark Administration (IBA), would
also need to be compliant with relevant regulations, particularly those regarding representativeness. Per the IBA’s website,
“there is no guarantee that any LIBOR settings will continue to be published after year-end 2021. Users of LIBOR should
not rely on the continued publication of any LIBOR settings when developing transition or fall back plans.”

LIBOR/SOFR Update – February 2020

Differences Between SOFR and LIBOR Tra Kelly, Director

LIBOR is a daily average of what banks say they would have to pay to borrow for another bank for various terms (i.e.
1-month LIBOR, 3-month LIBOR). The rate is forward-looking, so borrowers know the interest rate for a given interest
period at the beginning of the period. This bank-to-bank lending is unsecured, so LIBOR also includes a credit risk
Differences Between SOFR and LIBOR
premium, while a RFR does not.
LIBOR is a daily average of what banks say they would have to pay to borrow for another bank for various terms (i.e. 1-month
SOFR on the other hand is a secured, overnight (backward looking), risk free rate based on actual transactions
LIBOR, 3-month
collateralized LIBOR). The rate is forward-looking, so borrowers know the interest rate for a given interest period at the
by Treasurys.
beginning of the period. This bank-to-bank lending is unsecured, so LIBOR also includes a credit risk premium, while a RFR
does not.

SOFR on the other hand is a secured, overnight (backward looking), risk free rate based on actual transactions collateralized
by Treasurys.
Summary of Key Differences
Summary of Key Differences

LIBOR
LIBOR SOFR
SOFR
Bank-to-Bank lending rate (includes credit risk) Risk-free rate (no credit risk)
Unsecured Secured with Treasurys
Forward looking Overnight - backward looking
Term structure No term structure
Based on bank submissions and expert judgement Transaction based
Based on roughly $1B transactions per day Based on roughly $1T transactions per day

While there are obvious advantages to moving to a truly market based RFR, there are significant challenges transitioning from
an unsecured forward term rate (LIBOR) to a secured overnight rate (SOFR):
• Due to the lack of a large, developed derivatives market, forward term SOFR is not currently available and may not
be an option at the time LIBOR is discontinued.
• Without a forward term rate, borrowers and lenders will not know a given interest payment until the end of each
interest period.
• What ‘spread’ will be added to SOFR to account for the credit risk premium associated with LIBOR (bank-to-bank
lending) and how will that spread be determined.
• Banks have reported significant changes will be required to their operations systems as well as loan documentation
to accommodate SOFR in arrears.
ARRC Paced Transition Plan
LIBOR is a daily average of what banks say they would have to pay to borrow for another bank for various terms (i.e. 1-month
LIBOR, 3-month LIBOR). The rate is forward-looking, so borrowers know the interest rate for a given interest period at the
beginning of the period. This bank-to-bank lending is unsecured, so LIBOR also includes a credit risk premium, while a RFR
does not. INTEREST RATE CAPS 101

SOFR on the other hand is a secured, overnight (backward looking), risk free rate based on actual transactions collateralized
by Treasurys.
Summary of Key Differences

LIBOR SOFR
Bank-to-Bank lending rate (includes credit risk) Risk-free rate (no credit risk)
While there are obvious advantages to moving to a truly market based RFR, there are significant challenges transitioning
Unsecured Secured with Treasurys
from an unsecured forward term rate (LIBOR) to a secured overnight rate (SOFR):
Forward looking Overnight - backward looking
Term
• Due to the lack of a large, developed derivatives market,No
structure term structure
forward term SOFR is not currently available and may not
Basedbeonanbank submissions and expert judgement
option at the time LIBOR is discontinued. Transaction based
Based on roughly $1B transactions per day Based on roughly $1T transactions per day
• Without a forward term rate, borrowers and lenders will not know a given interest payment until the end of each
While there are period.
interest obvious advantages to moving to a truly market based RFR, there are significant challenges transitioning from
an unsecured forward term rate (LIBOR) to a secured overnight rate (SOFR):
• • What ‘spread’
Due to willofbe
the lack addeddeveloped
a large, to SOFR to account for
derivatives the credit
market, riskterm
forward premium
SOFR associated with available
is not currently LIBOR (bank-to-bank
and may not
lending) and how will that spread be determined.
be an option at the time LIBOR is discontinued.
• • Banks
Without a forward
have reportedterm rate, borrowers
significant andbe
changes will lenders will to
required nottheir
know a given interest
operations systemspayment
as well until thedocumentation
as loan end of each
tointerest
accommodate
period. SOFR in arrears.
• What ‘spread’ will be added to SOFR to account for the credit risk premium associated with LIBOR (bank-to-bank
lending) and how will that spread be determined.
• Banks have reported significant changes will be required to their operations systems as well as loan documentation
to accommodate SOFR in arrears. ARRC Paced Transition Plan
ARRC Paced Transition Plan
The ARRC also released the Paced Transition Plan, outlining specific steps and timelines to ensure a smooth
The ARRC also released
transition. Belowthe
is Paced Transition
an outline Plan,
of those outlining
steps specific
and the steps
current and timelines to ensure a smooth transition. Below
progress.
is an outline of those steps and the current progress.

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 INTEREST RATE CAPS 101

LIBOR/SOFR Update – February 2020

LIBOR/SOFR Update –Tra
February 2020
Kelly, Director
Tra Kelly, Director

ISDA’s Methodology
ISDA’s Methodology - Compounded SOFR- Compounded SOFR in Arrears
in Arrears
ISDA’s
The The Methodology
market
market willwill need
need - to
Compounded
tocome
cometo toaaSOFR in Arrears
consensus
consensus asastotohowhowSOFRSOFRis calculated and and
is calculated implemented
implementedin bothin cash
bothand derivative
cash and derivative
instruments. Ideally both willwill
have identical fallback language, preventing
preventinganyanypotential
potential mismatch between the loan and
The market will need to come to a consensus as to how SOFR is calculated and implemented in both cash and derivativeand the
instruments. Ideally both have identical fallback mismatch between the loan
the hedge.
hedge.
instruments. Ideally both will have identical fallback language, preventing any potential mismatch between the loan and the
hedge.
The International
The International Swaps
Swaps andandDerivatives
Derivatives Association (ISDA)isisactively
Association (ISDA) actively working
working to amend
to amend the 2006
the 2006 ISDA Definitions
ISDA Definitions to
to include
include new language
new language referencing
referencing SOFR as SOFR as the replacement
the replacement indexisifnoLIBOR
index if LIBOR longerisavailable.
no longerTheavailable.
amended The amended
definitions aredefinitions
The International Swaps and Derivatives Association (ISDA) is actively working to amend the 2006 ISDA Definitions to include
are expected
expectedtotobebereleased
released in the
in the firstfirst
halfhalf of 2020,
of 2020, with Bloomberg
with Bloomberg beginning
beginning to publish
to publish compounded
compounded SOFR shortly
SOFR averages averages
new language referencing SOFR as the replacement index if LIBOR is no longer available. The amended definitions are
thereafter.
shortly thereafter.
expected to be released in the first half of 2020, with Bloomberg beginning to publish compounded SOFR averages shortly
thereafter.
ISDA is also planning
ISDA is also planningtotoissue issue a 2020
2020IBORIBORFallbacks
Fallbacks Protocol,
Protocol, allowing
allowing counterparties
counterparties withwith existing
existing tradestrades to incorporate
to incorporate the
the new
newreplacement
replacementlanguage.language.
ISDA is also planning to issue a 2020 IBOR Fallbacks Protocol, allowing counterparties with existing trades to incorporate the
new
ISDA’s replacement
methodology
ISDA’s methodologylanguage.
forfor calculating
calculatingSOFR SOFRwill
will be the compounded
be the compoundedaverage averageofofthethe daily
daily SOFRSOFR
overover the reference
the reference period. period.
Unlike LIBOR,
Unlike which
LIBOR, which is set at the
iscalculating beginning
set at the SOFR of each payment period, the applicable compounded SOFR
beginning of each payment period, the applicable compounded SOFR will not be determined will not be
ISDA’s methodology
determined until thefor end of the period.will be the compounded average of the daily SOFR over the reference period.
untilLIBOR,
Unlike the end of the
which period.
is set at the beginning of each payment period, the applicable compounded SOFR will not be determined
For
For example, on a LIBORbased
example,
until the end on
of a LIBOR
the period. basedfinancing,
financing, the rate is fixed, in advance, at the beginning of the period and the interest
the rate is fixed, in advance, at the beginning of the period and the interest
payment is due at the end of the period. Borrowers and lenders also know the interest payment amount at the start of
payment
For period
example, is due
on atheat
LIBORthe end of the period. Borrowers andinlenders also
atknow the interest payment
periodamount
and theat the start of the
the when ratebased financing, the rate is fixed,
is fixed. advance, the beginning of the interest
periodiswhen
payment due atthetherateend is fixed.
of the period. Borrowers and lenders also know the interest payment amount at the start of the
period when the rate is fixed.

For
Fora SOFR
a SOFR based financing
based usingusing
financing the compounded in arrears
the compounded variant,variant,
in arrears the SOFRthe
fix SOFR
is not determined until the end
fix is not determined of the
until the
end of the period. Borrowers and lenders would not know the precise interest payment until a few days before
Forperiod.
a SOFR Borrowers and lenders
based financing would
using the not know in
compounded thearrears
precisevariant,
interestthe
payment
SOFR fixuntil a few
is not days before
determined untilthe
thepayment is due.
end of the
the payment is due.
period. Borrowers and lenders would not know the precise interest payment until a few days before the payment is due.

To account for the credit risk premium included in LIBOR, a spread will be added to SOFR based on the five-year historical
To median
accountbasis
To account between
forcredit
for the the premium
the credit
risk two rates.
risk The goal
premium
included inisLIBOR,
for the
included a two
in rates
LIBOR,
spread a to bebeadded
spread
will economically
willtobeSOFR neutral.
added to on
based SOFR
the based onhistorical
five-year the five-
yearbasis
median historical
between median
the two basis between
rates. The goalthe twothe
is for rates.
two The
ratesgoal
to beiseconomically
for the two neutral.
rates to be economically neutral.
Because ISDA governs all derivative transactions, it has the ability to incorporate changes more consistently and universally
Because
than possibleISDA
on governs
theallloan all derivative transactions, it has the ability to incorporate changes more consistently
side.
Because ISDA governs derivative transactions, it has the ability to incorporate changes more consistently and universally
and
10800 universally
Sikes Plon
Suite 220than possible on the loan side. (704) 887-9880
than possible the loan side.
Charlotte,
10800 Sikes PlNC 28277
Suite 220 (704)Pensford.com
887-9880
Charlotte, NC 28277 Pensford.com
 LIBOR/SOFR UPDATE – FEBRUARY 2020

TRA KELLY, DIRECTOR

LIBOR/SOFR Update – February 2020
Tra Kelly, Director

Forward-looking Term SOFR

Forward-looking Term SOFR
Some market participants have expressed a desire for a forward-looking, term SOFR (i.e. 1-month or 3-month SOFR) that
Some
wouldmarket participants
represent haveexpectations
the market’s expressed a desire for over
for SOFR a forward-looking, termThis
the relevant term. SOFRstructure
(i.e. 1-month
wouldor 3-month
feel SOFR) to
very similar thatthe
would represent
existing the market’s
LIBOR loans familiar expectations
to borrowers, for SOFR
with the over the relevant
interest rate beingterm.
set atThis
thestructure
beginningwould feel payment
of each very similar to theIt
period.
existing LIBOR
would also beloans familiar
easier to borrowers,
to incorporate with the interest
a forward-looking termrate
SOFRbeing
intoset at the beginning
existing loan docs toof each payment
replace LIBOR period. It would
rather than the
compounded setting in arrears structure favored by ISDA, which would require a significant amount
also be easier to incorporate a forward-looking term SOFR into existing loan docs to replace LIBOR rather than theof changes to existing
loan docs. setting in arrears structure favored by ISDA, which would require a significant amount of changes to existing
compounded
loan docs.
Forward-looking term rates would be based on SOFR futures and are dependent on the development of a large and
robust derivatives market. While the CME began offering SOFR futures in May 2018 and trading volume has been growing
Forward-looking term rates would be based on SOFR futures and are dependent on the development of a large and robust
consistently, the size of the market is still relatively small compared to LIBOR.
derivatives market. While the CME began offering SOFR futures in May 2018 and trading volume has been growing
For example,the
consistently, at size
the end of market
of the 2019 there was
is still about $345B
relatively of outstanding
small compared SOFR swaps, which represents just 1% of the
to LIBOR.
notional value tied to USD LIBOR swaps. This is especially true for longer maturities, as roughly 80%+ of current SOFR
For example,
swaps are foratterms
the endof of 2019 there
2 years was
or less, aboutthe
making $345B of outstanding
construction SOFR
of SOFR swaps,curve
forward which represents2+just
challenging 1% of
years theAsnotional
out. you
can see below, while the proportion of SOFR swaps with tenors of 2+ years is increasing, it still represents a relatively
value tied to USD LIBOR swaps. This is especially true for longer maturities, as roughly 80%+ of current SOFR swaps are for
small of
terms percentage
2 years orofless,
themaking
total market.
the construction of SOFR forward curve challenging 2+ years out. As you can see below,
while the proportion of SOFR swaps with tenors of 2+ years is increasing, it still represents a relatively small percentage of the
total market.
LCH LCH
SOFR Swaps by Tenor
SOFR Swaps by Tenor

Source: Clarus Financial Technology

Source: Clarus Financial Technology

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 LIBOR/SOFR UPDATE – FEBRUARY 2020

TRA KELLY, DIRECTOR

LIBOR/SOFR Update – February 2020
Tra Kelly, Director

A Brief History – Forward-looking

A Brief SOFR
History – Forward-looking term
SOFR term rates since
rates since inception
inception

Source: Federal Reserve Bank of New York

Futures derived forward SOFR term rates not likely available by the time of LIBOR’s discontinuation
Futures derived forward SOFR term rates not likely
Unfortunately, regulators believe there is a strong possibility that SOFR derivatives markets will not reach the required
available bybythe
breadth and depth timeregulatory
2021 to produce of LIBOR’s discontinuation
compliant forward rates. The International Organization of Securities
Commissions (IOSCO) is recognized as the global standard setter for securities regulation. The New York Fed updated its
Unfortunately,
Statementregulators believewith
of Compliance there
theisIOSCO
a strong possibility
Principles that SOFR
for Financial derivativestomarkets
Benchmarks will not
cover SOFR. Thereach the“independently
NY Fed required
breadth and depth by 2021 to produce regulatory compliant forward rates. The International Organization of Securities
reviewed the organizational and operational framework used to administer the SOFR…with respect to governance, quality of
Commissions (IOSCO) is recognized as the global standard setter for securities regulation. The New York Fed updated its
the benchmark, quality of the methodology, and accountability and determined that these reference rates are also in
Statement of Compliance with the IOSCO Principles for Financial Benchmarks to cover SOFR. The NY Fed “independently
compliance
reviewed with the (IOSCO)
the organizational Principles.”framework used to administer the SOFR…with respect to governance, quality
and operational
of the benchmark, quality of the methodology, and accountability and determined that these reference rates are also in
A forward-looking rate would be more akin to the current LIBOR structure and easier for banks to implement both from an
compliance with the (IOSCO) Principles.”
operations and documentation perspective. But as previously mentioned, ISDA has elected to use the compounded in
A forward-looking rate would
arrears methodology be more
as the akin to index,
replacement the current LIBOR
creating structuremismatch
a potential and easier for banks
between the to implement
fallbacks both
on the loanfrom
and on the
an operations and documentation perspective. But as previously mentioned, ISDA has elected to use the compounded in
related hedge. And while a forward-looking term rate could still be hedged, it involves additional complexity and cost.
arrears methodology as the replacement index, creating a potential mismatch between the fallbacks on the loan and on
the related
Given hedge. And lack
the current whileofaaforward-looking term rate
robust SOFR derivative couldtostill
market be hedged,
derive it involves
forward-looking additional
SOFR complexity
term rates and ISDAand cost.
implementing
Givencompounded SOFR
the current lack ofas
a the fallback
robust SOFRfor hedges, most
derivative CRE
market to borrowers should seriously
derive forward-looking SOFRconsider the ARRC’s
term rates Hedged Loan
and ISDA
Approachcompounded
implementing discussed below.
SOFR as the fallback for hedges, most CRE borrowers should seriously consider the ARRC’s
Hedged Loan Approach discussed below.

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 LIBOR/SOFR UPDATE – FEBRUARY 2020

TRA KELLY, DIRECTOR

ARRC Recommendations
The ARRC has provided three recommended approaches for borrowers of Floating Rate Loans to consider: Hardwire
Approach, Amendment Approach, and Hedged Loan Approach. While these approaches were originally designed for
new financings, the language can be amended into current loan docs. If you are a floating rate borrower that often
enters accompanying interest rate hedges, the Hedged Loan Approach needs to be seriously considered. The other
recommended approaches create a potential mismatch between your loan and hedge.

Hardwire Approach For example, following a trigger event, the lender is

This approach provides a waterfall of benchmark
replacements. The first option in the waterfall is a
forward-looking term SOFR (if available), which will
cause mismatches in how the interest expense on the
associated hedge is calculated compared to the loan, as
the hedge will use the ISDA fallback.
Note, the market has been slow to adopt the Hardwire
Approach, likely due to the lack of flexibility.
For more details on the Hardwired Approach and
the options in the waterfall, please view the ARRC’s
presentation here.
Amendment Approach
While the Hardwire Approach includes a waterfall of
specific fallback rates, the amendment approach does
not identify the successor rate or spread adjustment.
Instead, it provides an amendment process for
negotiating the fallback rate in the future. Similar to the
language commonly included in current loan agreements
for “LIBOR Replacement”, but the Amendment Approach
expands that language to include specificity around the
process and parameters for selecting the benchmark
replacement, specific trigger events for the transition,
and inclusion of a benchmark replacement adjustment.
required to give consideration to any selection or
recommendation by the Fed, the ARRC, or any then-
prevailing market convention for similar loans.
Hedged Loan Approach
The intent of this approach is to ensure the
replacement index is identical in both the loan and
associated hedge. Essentially, the loan side will default
to whatever fallbacks ISDA implements for derivatives.
Per the New York Fed, “To the extent borrowers wish to
ensure their bilateral business loan fallbacks are aligned
with those for related derivatives referencing the ISDA
definitions, the hedged loan approach provides certainty
in this regard.”
This language would need to be negotiated and agreed
upon upfront or amended into existing loan docs. While
it may make some borrowers unsettled to not know the
exact interest payment for a given period until days
before the payment is due, this is the only option
that ensures the hedge and loan match. And while the
interest expense is not known upfront, it does have the
benefit of better reflecting actual funding cost over the
period, not the market’s projections.
For more details on the mechanics of each approach,
please find the “ARRC Recommendations” here.
 LIBOR/SOFR UPDATE – FEBRUARY 2020

TRA KELLY, DIRECTOR

LIBOR/SOFR Update – February 2020

Tra Kelly, Director

LIBOR v SOFR – Historic Comparison LIBOR/SOFR Update – February 2020

Tra Kelly, Director
A common concern with borrowers is the volatility in the repo market. While SOFR is more volatile than LIBOR on a day-
LIBOR v SOFR – Historic Comparison
to-day basis, much of the volatility is smoothed out when we take the compound average of SOFR over a 1-month or
3-month period.concern
A common Even ifwith
SOFR spiked is
borrowers forthea volatility
couple daysin theduring the interest
repo market. period,
While SOFR the volatile
is more overallthan
effect on on
LIBOR thea compounded
day-to-
SOFR reset for that period is significantly muted.
day basis, much of the volatility is smoothed out when we take the compound average of SOFR over a 1-month or 3-month
LIBOR v SOFR – Historic Comparison
period. Even if SOFR spiked for a couple days during the interest period, the overall effect on the compounded SOFR reset for
As shown below, daily SOFR prints can experience sharp spikes, especially around quarter and year end, while 1-month
that period concern
is significantly muted. is the volatility in the repo market. While SOFR is more volatile than LIBOR on a day-to-
LIBOR Aiscommon
relatively smooth. with borrowers
day basis, much of the volatility is smoothed out when we take the compound average of SOFR over a 1-month or 3-month
As shown below, daily SOFR prints can experience sharp spikes, especially around quarter and year end, while 1-month LIBOR
period. Even if SOFR spiked for a couple days during the interest period, the overall effect on the compounded SOFR reset for
is relatively smooth.
that period is significantly muted. 1-month LIBOR vs daily SOFR
1-month LIBOR vs daily SOFR
As shown below, daily SOFR prints can experience sharp spikes, especially around quarter and year end, while 1-month LIBOR
is relatively smooth.
1-month LIBOR vs daily SOFR

Fortunately, a borrower’s SOFR reset for a given period will not be based on a single SOFR print. The effect of averaging daily
SOFR over
Fortunately, a 1-month SOFR
a borrower’s term significantly
reset for areduces the volatility.
given period will notForbe
example,
based SOFR
on aspiked
singleatSOFR
the end of 2018,
print. The but as you
effect of can
averaging
see below the impact on 1-month compounded SOFR was minimal.
daily SOFR over a 1-month term significantly reduces the volatility. For example, SOFR spiked at the end of 2018, but as
you can see below
Fortunately, the impact
a borrower’s on reset
SOFR 1-month
for a compounded
given period willSOFR was
not be minimal.
based on a single SOFR print. The effect of averaging daily
1-month LIBOR vs 1-month compounded SOFR
SOFR over a 1-month term significantly reduces the volatility. For example, SOFR spiked at the end of 2018, but as you can
see below the impact on 1-month compounded SOFR was minimal.
1-month LIBOR vs 1-month compounded SOFR
1-month LIBOR vs 1-month compounded SOFR

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 LIBOR/SOFR UPDATE – FEBRUARY 2020

TRA KELLY, DIRECTOR

LIBOR/SOFR Update – February 2020

Tra Kelly, Director

The smoothing effect is more evident as we increase the reference interest period. For example, 3-month compounded
SOFR actually displays less volatility than 3-month LIBOR.

The smoothing effect is more evident as we increase the reference interest period. For example, 3-month compounded SOFR
actually displays less volatility than 3-month LIBOR.
3-month3-month
LIBOR vs 3-month compounded SOFR
LIBOR vs 3-month compounded SOFR

Conclusion

Conclusion
Many details are expected over the coming months that will help provide great clarity and direction to borrowers as to the
best ways to prepare for LIBOR’s cessation. At the top of the list is ISDA’s amended fallback definitions for both new trades
Many
anddetails are expected
legacy trades. Bottom overline, athe coming
LIBOR hedgemonths
today is that will help
not going providebegreat
to suddenly clarity
worthless andLIBOR
when direction to borrowers as
is discontinued.
to the best ways to prepare for LIBOR’s cessation. At the top of the list
Intense focus is on making any replacement RFR economically neutral to current LIBOR.is ISDA’s amended fallback definitions for both
new trades and legacy trades. Bottom line, a LIBOR hedge today is not going to suddenly be worthless when LIBOR is
discontinued.
For the timeIntense
being, it focus
is worthis discussing
on making theany replacement
Hedged RFR economically
Loan Approach neutral to
regarding replacement currentinLIBOR.
language new financings.
Once lenders have a chance to review and get comfortable with the details of ISDA’s calculation methodology for the SOFR
For the time being, it is worth discussing the Hedged Loan Approach regarding replacement language in new financings.
fallback (triggers for transition, look-backs, pay delays, compounding in arrears, etc.), they are more likely to encourage
Once lenders have a chance to review and get comfortable with the details of ISDA’s calculation methodology for the
adoption on the loan side.
SOFR fallback (triggers for transition, look-backs, pay delays, compounding in arrears, etc.), they are more likely to
encourage adoption
So how much shouldonyou the loan
care side.
right now? While the situation is certainly in flux, progress towards a consensus is being made.
Again, we should see a further bump in SOFR activity following ISDA’s release of their amended 2006 Definitions. If lenders
So how much should you care right now? While the situation is certainly in flux, progress towards a consensus is being
start adopting the Hedged Loan Approach, the overall impact on your financing cost should be minimal. Regulators are
made. Again, we should see a further bump in SOFR activity following ISDA’s release of their amended 2006 Definitions.
paying close attention to any potential value transferal between parties due to the transition.
If lenders start adopting the Hedged Loan Approach, the overall impact on your financing cost should be minimal.
Regulators are paying close attention to any potential value transferal between parties due to the transition.

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