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On Nov. 6, 2020, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) (the agencies) issued a statement reminding banks they do not endorse a specific replacement rate for LIBOR for loans. Banks and credit unions may determine which reference rate to use for loans according to their funding models and the needs of customers. However, they are encouraged to add fallback language to lending contracts that allows for the use of fallback rates if the initial reference rate is discontinued.
As referenced in the Federal Financial Institutions Examination Council’s (FFIEC) recent joint statement, new contracts are advised to either use a non-LIBOR reference rate or add fallback language including a clearly-defined alternative rate prior to LIBOR’s discontinuation. The Alternative Reference Rates Committee (ARRC) assembled to ensure an effective transition from LIBOR and endorsed the Secured Overnight Financing Rate (SOFR) as a preferred option for cash and derivative transactions alike. The use of SOFR is not required but is a widely agreed-upon alternative rate.
The agencies acknowledge the differences in funding models and when structuring lending activities, it makes the most sense for banks and credit unions to determine their own suitable LIBOR replacement rates. Some of these options may include credit-sensitive LIBOR alternatives. The agencies advise banks and credit unions to evaluate the appropriateness of reference rate alternatives with their funding models and the needs of their customers/members. When adding fallback language that allows for a fallback rate if the initial rate is discontinued, banks and credit unions, along with and their customers and members, will be safeguarded from interruptions in available reference rates.
When it comes time to identify and alleviate LIBOR transaction risks, institutions should have risk management processes in place. Examiners will not condemn banks or credit unions for using a reference rate (such as a credit-sensitive rate) other than SOFR for loans.
The agencies urge banks and credit unions to strategize appropriate reference rates for lending purposes and to begin phasing loans away from LIBOR as soon as possible. Reach out to lending customers/members to advise of the transition from LIBOR to prevent any miscommunication. To prepare for the transition, the agencies also advise banks and credit unions to plan for any technical impact that new reference rates or fallback rates may have on internal systems.
If your institution needs assistance in preparing for the transition from LIBOR, please contact Doeren Mayhew’s Financial Institutions Group today.
This publication is distributed for informational purposes only, with the understanding that Doeren Mayhew is not rendering legal, accounting, or other professional opinions on specific facts for matters, and, accordingly, assumes no liability whatsoever in connection with its use. Should the reader have any questions regarding any of the news articles, it is recommended that a Doeren Mayhew representative be contacted.
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