Brace for Impact: CRE Finance Implications as LIBOR Transition Approaches
(Andrew Foster is Associate Vice President in MBA’s Commercial/Multifamily Group. He is a former Analyst with S&P Global Ratings and Fitch Ratings as well as a regular contributor to MBA NewsLink. He can be reached at email@example.com.)
“After 2021, we believe that continued use of LIBOR in new contracts would create safety and soundness risks, and we will examine bank practices accordingly,” Federal Reserve Vice Chair Randal Quarles.
The finance industry’s march towards transition away from LIBOR index continues as the third quarter approaches. For all the talk of upward revisions to economic growth projections, the market still awaits the first balance sheet commercial mortgage loan based on SOFR index.
LIBOR is the index most often used in the pricing of some trillion dollars of floating-rate commercial mortgages, which is a significant portion of outstanding commercial mortgage debt. For about 30 years, LIBOR has been the go-to rate for pricing all types of non-fixed-rate financial instruments, including mortgages, credit cards and a host of derivative products.
The transition creates a two-fold problem for commercial real estate lending. First, it changes the interest benchmark for new adjustable-rate mortgages. This may alter the economics of these loans because the replacement index will not produce an identical benchmark rate. Second, a transition to a new index will impact legacy mortgage loans made pre-transition that have been tied to LIBOR. For LIBOR-based loans that do not mature before 2023, the transition to a new rate is no minor detail. A new benchmark effectively alters the original terms of the contracts for adjustable-rate mortgages. The ARRC, in consultation with the industry, has put much effort into developing contractual fallback language to resolve some of the legal issues involved with transitioning loans that are tied to LIBOR. This type of transition work will continue in the years to come.
Two Steps Forward, One Step Back: Recent Regulatory and Legislative Developments
On March 5, the ICE Benchmark Administration confirmed it would extend the date for various tenors of US dollar LIBOR ceasing to be published from year end 2021 to June 30, 2023. These tenors include overnight, as well as one-, three-, six- and 12-month US dollar LIBOR. The goal of the extension was to allow a meaningful percentage of legacy contracts to mature naturally.
On March 24 the New York state legislature passed a bill to support the transition of LIBOR for those contracts governed by NY law with no fallback provision or a fallback to a USD-LIBOR based rate. MBA and the New York MBA sent a letter of support for this bill in January. It allows existing contracts to use replacement indices recommended by regulators when LIBOR is no longer available, providing safe harbors in certain situations. This follows confirmation by LIBOR’s administrator that it would cease publication of representative USD LIBOR for the major LIBOR settings in mid-2023.
On April 15, the House Financial Services Subcommittee on Investor Protection, Entrepreneurship and Capital Markets convened for a virtual hearing, “The End of LIBOR: Transitioning to an Alternative Interest Rate Calculation for Mortgages, Student Loans, Business Borrowing and Other Financial Products.” The hearing featured government witnesses from federal financial regulatory agencies including the Federal Housing Finance Agency, Federal Reserve, Office of the Comptroller of the Currency, Securities and Exchange Commission and the U.S. Treasury, and was intended to focus on draft legislation that would provide a clear federal framework and a legal safe harbor for transitioning away from the LIBOR index. The draft text can be found here. Additionally, MBA, along with several industry trade groups, sent a letter to the House Financial Services Committee in support of federal legislation to address “tough legacy” contracts that utilize LIBOR.
Members of Congress from both parties and all the witnesses agreed federal legislation is the best path forward. MBA is working with Congress and regulatory agencies on the draft legislation, which could see a vote this Congress.
Lastly, in a client note highlighting recent ARRC announcements and regulatory developments, Joseph Forte, General Counsel at AmTrust Title explains,
“Given the continued growth and the sheer size of current legacy LIBOR-based contract exposures, and the Bank Regulators’ efforts to minimize the potential legal uncertainty and adverse economic consequences and risks to the financial system generally resulting from a disruptive and unstable cessation, the Fed Vice Chair was extremely blunt when he said at the ARRC’s recent SOFR Symposium that:
‘[t]hese announcements are absolutely not meant to support new LIBOR activity or continued business as usual. Instead, they are meant to completely end the new use of LIBOR while allowing a significant portion of legacy contracts to roll off before the key dollar LIBOR tenors stop publication.’” (emphasis in original)
In other words, take very seriously the regulatory warnings and just stop originating new (or extending legacy) LIBOR-based loans now with the guidance that the ARRC has provided to accelerate the transition.
Arc of LIBOR History Bends Towards SOFR– Webinar May 10 from2:00-3:00 p.m. ET
Investment and finance industries including commercial real estate continue towards the pending transition away from LIBOR benchmarks for floating rate debt. Mortgage Bankers Association Commercial/Multifamily LIBOR Working Group chair, Reena Pally, Metlife Investment Management will moderate a conversation with varied CRE finance industry experts who will share their expectations, insights, and experiences.
Join to get the latest details as well as relevant timelines and industry developments from a broad cross section of market participants. Register here.
– What has been the experience of the GSEs?
– What movements are in process with CRE CLO market?
– Where are balance sheet lenders with respect to transition and timeline
for writing floating rate loans referencing SOFR?
– Where is the marketplace in terms of SOFR calculation and what’s been working?
– What is the landscape for derivatives and interest rate caps?
Matt Hoffman, Director, Chatham Financial
Richard Jones, Partner, Dechert
Dan Olsen, Senior Vice President, KeyBank
Christopher Speaker, Senior Policy Analyst, Multifamily, Federal Housing Finance Agency