Timing is everything. I published a piece two weeks ago on LIBOR transition to SOFR and suggested that folks get on with it and embrace this flawed but seemingly inevitable new SOFR index. Writing that piece, I thought of as rather an exercise in self-care, I just had to get beyond my annoyance with SOFR and stop worrying about SOFR and embrace it with all its flaws and join the SOFR chorus.So what happened? This past Friday, November 6, 2020, the Fed, the Office of the Comptroller and the FDIC collectively published a curious statement “reiterating” (I don’t actually remember the iteration for which this is a “re”) that they are not endorsing a specific replacement rate for LIBOR, but urging the banks to begin including fallback language right away to avoid the increasingly likely chaotic end to the time of LIBOR. In a backhanded sort of way, SOFR at least gets a mention as an alternative, but in a very prominent footnote, the powers muse, “Some banks have noted that SOFR is a near-risk-free rate and does not reflect banks’ underlying funding costs. These banks have advocated for the development of a credit-sensitive rate, or a credit-sensitive spread, that could be added to SOFR to better reflect bank’s funding costs.” Official sector representatives (don’t you love that term?) recently held a series of workshops with banks and borrowers to discuss potential credit sensitive alternatives to the use of SOFR for loan products. Our understanding is that this official sector coterie came up with naught.
Huh? We’re going to start considering alternatives now? Really? The absence of a credit-sensitive component to SOFR has haunted the LIBOR replacement process since inception. It is the elephant in the room: large, stinky and potentially dangerous but essential to ignore if we were going to get on with it and embrace SOFR.
All efforts to stitch a credit-sensitive component onto SOFR, a Frankenstein’s monster to be sure, including the most recent, have devolved into magical thinking that we’ll just somehow get over it. The effervescence of sophistry.
So is this a tell, a wink, from the regulatory heights that we’re not really done with sorting out our LIBOR replacement? It may not be all SOFR all the time? Just the other day, I saw that Signature Bank has just priced a $375 million bond using Ameribor. Well, there you go. Proof, of a sort, that a LIBOR- and SOFR-free alternate universe could exist.
I’m not sure whether I want to cheer this on or cower in fear that any speedbump on the way to a January 2022 SOFR conversion will create massive and unmanageable problems.
Look, tying billions – if not trillions – of dollars of floating rate debt to an index that is not credit-sensitive is not going to be good. It’s going to continue to carry with it, month in and month out, year in and year out, the real possibility of a significant transfer of value from lenders to borrowers (or vice versa) will risk suppression of capital formation. Every time I think that, I’ve a mind to cheer Ameribor and any of the other competing credit-sensitive indices that the New York Fed has not quite entirely succeeded in tossing (the private sector continues to try, there was the news last week that Bloomberg is working on a credit-sensitive bolt-on to SOFR) on the tumbrel of failed alternative SOFR wannabees.
If everyone sticks to SOFR, begins to use it right now and work through all the problems that actual use will illuminate, there’s a possibility, a real chance, we could avoid a chaotic end to LIBOR, a bare 13 months from now. And that’s the optimist in me talking. If the choice of index is back in play, a conversation that we should have had some two-plus years ago and it results in even a pause, a half halt, in everyone’s conversion timetable, a chaotic exit is almost assured. If there’s now real uncertainty as to what the prudential regulators think we ought to do, then we better had go find a patch real quick. Another year of LIBOR quotes anyone? Given the work that still needs to be done to build internal underwriting and valuation models, to educate one’s staff, to educate the borrower community and the mortgage bankers to build out new hedging structures, to create new loan documents and deal with the legacy book, any uncertainty this close to the termination date of LIBOR looks like a disaster.
So what are you playing at in the Olympian heights of the regulatory state? We need more than just a tell and a wink here.