Banks consider alternatives to Libor as companies seek to manage interest rate risk
Some big banks are weighing whether the benchmark rate backed by regulators as the best replacement for the scandal-ridden London interbank rate is the only option for companies, or whether they should offer other rates.
Many large US financial institutions offer the Guaranteed Overnight Financing Rate, or SOFR, to corporate borrowers as part of the Libor transition.
But SOFR may not cover all business needs, according to banks and business advisers, as the benchmark lacks rates weeks or months into the future, making it difficult for businesses to plan for future interest rate risk.
Lenders are considering offering index rates such as the American Interbank Offered Rate (Ameribor) or the Bloomberg Short Term Bank Yield Index (BSBY) as alternatives. More research still needs to be done to determine how these alternative rates would perform in the event of an economic downturn and whether there is sufficient trading volume to generate a reliable benchmark measure, according to the banks. As regulators urge banks to offer SOFR for capital markets and derivative transactions, the Federal Reserve says it is open to other rate options for loans and other financial instruments.
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These alternative SOFR rates are credit sensitive, which means that they more accurately reflect the financing costs of lenders. For example, clothing company Duluth Holdings received a corporate syndicated loan linked to BSBY in May, citing lower borrowing costs, CFO David Loretta said on a June earnings conference call. . Duluth has a relatively healthy financial risk profile, said CreditRiskMonitor, a provider of commercial credit reports. The company did not respond to a request for comment. Other corporate borrowers are looking for competing rates as the year-end Libor expiration date approaches.
This search for a benchmark rate for corporate loans began after authorities decided to phase out Libor by the end of 2021. A widespread manipulation scandal has led to sanctions for banks and convictions for certain traders. Until then, Libor has helped fix borrowing costs on everything from business loans to mortgages around the world, and is the benchmark rate for billions of dollars in financial contracts.
Banks cannot issue new financial contracts using Libor after December 31, but can continue to benchmark it for many existing debts until June 2023.
The SOFR, which has become the benchmark rate favored by regulators and the Fed, is a retrospective measure based on the cost of transactions in the overnight buyback market. Many banks and regulators prefer this as an alternative to Libor, claiming it is robust enough to support a large volume of financial transactions and products. Last month, a group of major banks, insurers and asset managers approved “Term SOFR,” a series of forward-looking SOFR benchmarks issued by derivatives exchange operator CME Group Inc. to promote wider market adoption. SOFR is based on a market of around one trillion dollars; Ameribor and BSBY for example are supporting tens of billions of dollars.
Still, some smaller regional banks use Ameribor, a rate created by Richard Sandor, president and CEO of electronic marketplace American Financial Exchange. They say the rate can change with their funding costs, reflecting what banks spend to lend to each other through mutual lines of credit. BSBY, owned by financial data and media firm Bloomberg, also sparked interest after Bank of America and JPMorgan Chase traded the first complex derivative using the index in May.
Truist Financial, a Charlotte, NC-based banking holding company, and PNC Financial Services Group offer SOFR and BSBY but not Ameribor. Truist CFO Daryl Bible said the bank offers BSBY in part because its similarity to Libor makes it a more familiar option for customers, but is monitoring how many companies are adopting it.
The rates for a three-month loan were 0.049%, 0.104% and 0.097% for Term SOFR, Ameribor and BSBY, respectively, as of August 12. The rates reflect different underlying market conditions, as Ameribor and BSBY have a credit component while SOFR does not.
It is difficult to determine whether one rate is better than another, as the appropriate credit spreads for each corporate borrower would also be a factor, said Amanda Breslin, managing director of treasury consulting at financial risk advisor Chatham Financial. Corp.
The big banks haven’t written off credit-sensitive rates, and say they monitor market trends and the performance of those index rates during market ups and downs.
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Wells Fargo is studying the use of Ameribor and BSBY in the commercial loan market, Treasurer Neal Blinde said.
Goldman Sachs is also considering offering credit sensitive rates based on customer demand and the strength of indices, Treasurer Beth Hammack said.
Banks will also need to show regulators that they are moving quickly to adopt a new benchmark.
“Our real concern with financial stability is to ensure that every contract has wording that specifies what happens when the chosen benchmark rate is not available, as any benchmark rate can die,” said Randal Quarles, president of the Financial Stability Board and Vice-President. for supervision at the Fed.
Already, the Chairman of the Securities and Exchange Commission, Gary Gensler, has said that BSBY poses similar risks to Libor to financial stability and market resilience. Both benchmarks are based on unsecured, term, bank-to-bank loans and constitute a modest market bearing the brunt of a substantial number of transactions, he said in a speech to the Financial Stability Supervisory Board in June.
“When a benchmark doesn’t match like that, there’s a hell of a lot of economic incentive to manipulate it,” Gensler said at the time. The SEC did not respond to a request for comment.
It is not clear when most of the big banks will decide on alternative rate offers. “The focus of our company has really been all product launches and preparation around SOFR,” said Blinde of Wells Fargo. “It’s too early to say if we’ll be active in any of the other markets, but we’re definitely evaluating them.”
This article was published by Dow Jones News Feeds.