With the lights almost out on the scandal-plagued Libor interest rate, a successor touted by regulators has quickly become the leading benchmark for business loans, outdueling two alternatives that some banks prefer.
The Secured Overnight Financing Rate, or SOFR, has taken an early lead partly because regulators see it as a stable interest-rate benchmark without the vulnerabilities of Libor. The London interbank offered rate is being phased out globally after a manipulation scandal years ago.
Banks’ rapid adoption of SOFR makes 2022 a critical year for the two leading alternatives in the United States: the Ameribor rate favored by some midsize lenders and Bloomberg’s BSBY rate, which has gotten traction among other regional and larger banks.
Many in the industry think BSBY and Ameribor have staying power. The next few months, however, will help determine whether SOFR becomes dominant.
“Until we get four or five months under our belts in the new regime … I'm going to hold my powder a little dry on whether this is a done deal or not,” said Richard Jones, a partner at the law firm Dechert, in reference to SOFR’s early lead.
As the post-Libor world takes shape, there may “eventually be a winner or two that dominate” the loan market like Libor did, said Matthew Tevis, managing partner at Chatham Financial, which advises banks on the issue.
Banks are using Ameribor and BSBY in certain business loans today, and some of them have made one of the two rates their primary benchmark instead of SOFR. Many bank loans are not public, making it hard to track progress precisely for each benchmark. But regulators, bankers and analysts say that SOFR is further ahead as the Libor transition hits a critical milestone.
“It’s definitely early days, but even within these early days, I am mostly seeing SOFR,” said Ilene Froom, a banking lawyer at the law firm Reed Smith, regarding new loans that do not reference Libor.
The picture could shift in the next few months, since banks are no longer supposed to make new Libor loans under regulatory guidance that took effect Jan. 1. The just-passed deadline is sure to spur more activity for all three benchmarks, as will the more gradual process of shifting legacy contracts away from Libor ahead of a mid-2023 deadline.
The possibility of a multirate world
Many in the industry see Ameribor and BSBY playing some role in a post-Libor world, and banks say they are gearing up for a multirate environment, in which they offer their clients a buffet of SOFR, Ameribor, BSBY and other rates that are waiting in the wings.
Regions Financial, for example, does not prefer any individual benchmark but offers all three rates because “different clients have varying needs for managing their finances,” said Libor transition lead Colleen Rabenstine.
Still, SOFR has quickly gained traction. The Federal Reserve
Wells Fargo, the country’s third-largest bank, has made SOFR its primary U.S. dollar Libor alternative and has used SOFR on some 3,200 loans to businesses and far more loans in consumer mortgages. “Our experience is customers want SOFR,” said Brian Grabenstein, who leads the bank’s Libor transition.
Other banks have dabbled far more in Ameribor and BSBY, or have made one of them their primary benchmark. A cadre of midsize banks have long expressed a preference for Ameribor, which is based on interbank lending rates and therefore more closely reflects those banks’ funding costs.
For example, Zions Bancorp. has seen many of its Libor-based borrowers switch to Ameribor without any issues, said Travis Craig, the Salt Lake City-based bank’s director of strategic initiatives. The bank also makes commercial loans using SOFR and BSBY, depending on customers’ needs.
Richard Sandor, the futures market pioneer who developed Ameribor, said he is “extremely optimistic” about Ameribor’s future as an alternative benchmark aimed at loans to middle-market companies. Demand for Ameribor products will increase as the new year begins, he said, comparing the last-minute Libor loans happening last month to “binge drinking” in the days before Prohibition officially began.
“We are focused in the first quarter of the new year for the real transition to take place as market participants will no longer be able to rely on Libor,” said Sandor, the chairman and CEO of the American Financial Exchange, the interbank lending market from which Ameribor is derived.
Some banks are also using BSBY in their non-public commercial loans, and the Bloomberg-developed benchmark has shown up on a few larger deals to publicly traded companies.
Bank of America, one of BSBY’s leading proponents, has arranged syndicated loans with other banks using BSBY. Those include a $150 million revolving loan to the retailer Duluth Holdings in May and a $2.3 billion loan in September to the trucking company Knight-Swift Transportation Holdings.
Regulators appear to prefer SOFR
SOFR’s lead is not unexpected. The Fed convened a group of market participants that landed on SOFR as the best Libor replacement in 2017, giving it institutional credibility from the start.
Some bankers initially had
Though bank regulators have said lenders can use rates other than SOFR, they rarely, if ever, miss a chance to highlight SOFR’s strengths. Many bankers and lawyers view their comments as a not-so-subtle nudge toward SOFR — or at the very least, an indication that using SOFR will lead to fewer questions from bank examiners.
The Office of the Comptroller of the Currency, for example,
“If your firm is moving to a rate other than SOFR, that means extra work for you to make sure you’re demonstrably making a responsible decision. Because you are going to be asked about that decision,” Held said.
Banks’ early concerns about SOFR
The industry's quick adoption of SOFR is happening despite some banks’ earlier concerns about the rate's viability in lending.
“We believe that SOFR, on a stand-alone basis, is not well suited to be a benchmark for lending products and have concerns that this transition will adversely affect credit availability,” executives at Regions, Zions, PNC Financial Services, Capital One Financial, Fifth Third Bancorp, M&T Bank and five other regional banks wrote in a 2019
The banks’ main concerns stemmed from the fact that SOFR is essentially a “risk-free” interest rate. Libor, BSBY and Ameribor are all credit-sensitive, so during times of stress, they tend to rise to reflect the tighter credit environment and stay elevated until the unease fades. That feature places the burden on borrowers to pay more interest in times of stress, helping banks because they, too, are facing a higher cost of doing business.
In contrast, SOFR would tend to fall and remain lower during times of stress — making it cheaper for borrowers but crimping banks’ profit margins.
Regulators responded to bankers’ worries with a series of virtual workshops held at the New York Fed starting in mid-2020.
Ultimately, the regulators
The central importance of a derivatives market
SOFR’s edge so far is partly due to its rapidly growing derivatives market, which lenders and borrowers can use to swap their interest rate risk with that of a counterparty, protecting themselves against rates turning up or down.
Without a large derivatives market, such protection can be more expensive, making it less appetizing for banks to make loans that require such swaps. The problem is that the derivatives market cannot grow without a supply of swappable loans to feed it.
SOFR faced that chicken-or-egg hurdle last year but cleared it, thanks in part to regulatory initiatives to change procedures in the derivatives market.
Thinner derivatives markets for BSBY and Ameribor are a “major deterrent” of more widespread usage of those rates, and it is unclear whether the issue will be solved, said Adrian Congiu, head of lending product management at Silicon Valley Bank.
Other bankers are a bit more optimistic. Regions Financial’s Rabenstine said the derivatives markets for BSBY and Ameribor “are still in their infancy and will require more time … to get underway.”
“While these rates do not have the derivatives volumes of SOFR, several financial market participants are working to facilitate the development of these products, which may close this gap in the future,” Rabenstine said.
In the meantime, some banks are making Ameribor and BSBY loans with little intention of eventually turning to the derivatives market.
“Certainly if it developed, we would love to take a look at how we could utilize it differently,” Craig at Zions said. “But to this point, it has not inhibited our ability to use Ameribor.”
Ameribor is further behind than BSBY in the development of derivatives, though it saw its
Staying small may be an asset
Though it is bigger than Ameribor’s, the derivatives market for BSBY remains far behind the SOFR market. That gap makes it more expensive for a bank that uses BSBY to hedge its interest rate risk, said Priya Misra, head of global rates strategy at TD Securities.
Misra was skeptical that the BSBY derivatives market “will become a lot more liquid,” given a lack of regulatory initiatives for BSBY like those that helped the SOFR market develop. A thin derivatives market could constrain the size of BSBY’s market, she said.
But that may end up being good news for BSBY, since a smaller presence may draw less attention from regulators. BSBY has repeatedly come under fire from Securities and Exchange Commission Chair Gary Gensler, who has
Gensler has said he doesn't think BSBY meets the principles that the International Organization of Securities Commissions laid out in 2013 for potential Libor replacements. Gensler co-chaired the IOSCO group tasked with coming up with those principles.
But Bloomberg
In a statement, Bloomberg said it is “committed to a smooth transition away from Libor.” In addition to its development of the BSBY rate, the company has launched tools to support the use of SOFR, Ameribor and alternative rates in other countries.
Officials from the Fed, the OCC and the Federal Deposit Insurance Corp. have not publicly voiced concerns about BSBY. If they do share Gensler’s views, they may stay mum on the topic as long as the Bloomberg benchmark does not become a major player, Misra said.
“If it stays a small market, I think the regulators might be OK with it coexisting,” Misra said.
