Will the End of LIBOR Affect Your Loans?

BY: Stanley D. Koopmans


LIBOR, which stands for London Inter-Bank Offered Rate, is set based on the average rate at which major global banks lend money to one another on a daily basis. For the past couple of decades, it has been used as the market-driven index to set interest rates for business loans, not just in the United States, but around the globe. And it is on the verge of ending.

The “inter-bank” in the acronym is the primary reason that LIBOR is being replaced. Since the global Great Recession, transactions among banks have been declining, making the LIBOR index less reliable and credible. In 2017, the United Kingdom regulator that oversees LIBOR stated it could not guaranty the index after 2021.

Here in the States, the Federal Reserve established the Alternative Reference Rates Committee (ARRC) to facilitate the transition away from LIBOR. AARC has recommended an index called the Secured Overnight Financing Rate (SOFR) as an alternative. It will be “secured” by repurchase agreements of U.S. treasuries.

Interest Rate Indexes

Note that SOFR will be another market rate index that will be used to set interest rates. Other indexes that have been and will continue to be used among banks include treasuries, the WSJ Prime Rate of Interest (as published in the Wall Street Journal and based on surveying the 30 largest banks in the country), and Advance Rates by the Federal Home Loan Bank of Chicago (FHLBC).

I started my banking career as an examiner. Back then, many banks established their own “prime” rate(s). When I started lending, the most frequently used index was U.S. treasuries. Banks transitioned away from treasuries to LIBOR as the interest rates were not necessarily driven by market forces, but by Federal Reserve fiscal policy.

For the past couple of years, State Bank of Cross Plains has transitioned away from LIBOR to FHLBC. In addition, standard loan documentation includes provisions for alternatives if an applicable index is no longer available.

Long-Term Fixed Rate Loans

For the past few years, and on larger transactions (over $1 million), State Bank of Cross Plains has been very active in successfully locking in attractive long-term (20 years +) fixed rates for many of our business customers, using hedges through an intermediary financial institution. These long-term rates have been particularly attractive as interest rates have been near historical lows. (I, for one, hope rates do not go much lower, as I have a hard time grasping negative interest rates, such as those that have occurred in Europe and Japan.)

For all these transactions, our customers pay a long-term fixed rate, while the bank receives a floating interest rate based on LIBOR. I have already started receiving calls from some customers with long-term fixed rates asking if their loan will be affected by LIBOR being phased out. The answer is “no,” there will not be any changes to your long-term fixed rate. We may, however, eventually need you to sign an acknowledgment that the LIBOR index referenced in the loan documents is no longer valid and has been replaced.

Rest Assured

State Bank of Cross Plains has been preparing, and will continue to prepare, for LIBOR’s denouement (a new word for me in 2021, defined as “the climax of a chain of events, usually when something is decided or made clear") so that it has no impact to our customers. In short, you have nothing to worry about.

As always, we encourage you to reach out and ask questions if you hear financial news that concerns or puzzles you. If you would like to learn more about LIBOR in general, Investopedia has some good background information. If you have a specific question about your existing or anticipated loan, contact your State Bank of Cross Plains commercial banker for clarification.

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