If you are in commercial real estate, you likely have current loans that are based on LIBOR, one of the largest financial benchmarks today, used for pricing swaps, futures, and loans worldwide.
On July 27, 2017, the U.K.’s Financial Conduct Authority (FCA), which oversees LIBOR reporting, announced that this benchmark, responsible for the pricing of about $350 Trillion in financial instruments today, is set to cease by the end of 2021.
The end of LIBOR will have a tremendous effect on financial institutions and customers with outstanding obligations, especially as it relates to commercial loans with floating interest rates.
In 2018, it was announced that the LIBOR index was most likely to be replaced with SOFR (secured overnight financing rate). The daily SOFR, which was first published by the New York Federal Reserve in April 2018, is based on transactions in the Treasury repurchase market, where investors offer banks overnight loans backed by their bond assets. If you already know what this means, you are ahead of 99 percent of the CRE investors today.
You might say the end of 2021 is 22 months away, but that’s not a long time.
If you have loans with maturities extending beyond December 31, 2021, you might want to consider how the phase-out of LIBOR will impact your loan(s), portfolio, or fund management. I can speculate that this will cause some market instability, as trillions of dollars worth of financial contracts that are based on LIBOR are forced to a new benchmark rate.
There’s still a lot of questions to be answered, but I do know that once you start understanding how this might impact your CRE, the financial institutions may or may not be able to tell you how it will affect your loan from their perspective.
Today many borrowers of CRE have significant issues with interpretation of language in their loan documents, both in commercial banking and the servicing world. Often, this language can be interpreted differently, or the “intent” of the language may cause the need for negotiation because of the impact on other loan calculations, and ultimately the property. This can result in technical defaults, cash traps, and the failure of coverage ratios, just to name a few. The use of LIBOR had become so commonplace; however, that many credit agreements failed to define a replacement for LIBOR, leaving ambiguities in the loan documents that will likely need to be remedied by future loan modifications.
One thing is for sure; it’s not too early to develop a plan for your commercial real estate portfolio.
Tanya Hart Little is the CEO of Hart Advisors, a commercial loan advisory firm.