Preparing for the LIBOR Transition

A discussion with experts from KeyBank, Jones Day and Ernst & Young

November 2020

Kelly Eckels, KeyBank

All right, hello and thank you for joining us today for our webinar on the upcoming LIBOR transition. My name is Kelly Eckels, I am with Key's training and development group, and I'll be moderating today's session. Our presenters have a wealth of information that we want to share with you, and we anticipate using the full hour for the material itself, therefore we do not plan to do a separate Q and A period, however, at the end of the program, I will share some information about where you can submit follow-up questions afterwards. With that, I'd like to turn the call over to Laurie Muller-Girard. She is our regional sales executive with Key's middle-market group to introduce the panelists. Thanks Laurie.

Laurie Muller-Girard, KeyBank

Thank you Kelly. Well, good afternoon everyone. As Kelly said, my name is Laurie Muller-Girard, and I am one of five middle market regional sales executives, in the line of business representative on the broad cross-functional KeyBank LIBOR transition team. This is an effort including many internal professionals from Key, it includes treasury, technology, legal, relationship managers, loan servicing, credit, training, and really the list goes on. It also involves many outside resources including experts in the legal and accounting field. I am delighted to welcome you to this call, and I'm confident that you will find value in the information that our panel will present. It will introduce the panelists in the order that they will present. And Tony Bulic will kick us off. Tony is KeyBank securitization and hedge manager with the team supporting our commercial real estate group. Currently he spends much of his time in keeping LIBOR transition program owner, helping to coordinate all of the bank’s efforts and resources to meet the client, bank and regulatory needs of the LIBOR transition in a timely, efficient and client-centric fashion for our LIBOR based borrowers. Next up will be Jason Jurgens. He is a New York based partner at Jones Day's financial markets practice. Jason is the leader of the firm’s Global cross- disciplinary LIBOR transition team that is advising financial institutions, investment companies, and corporate issuers. Jeff Vitali will join us. He is a partner in E&Y financial services practice, and one of the firm's LIBOR solution campaign leaders. He assists clients navigating the end to end operational challenges the LIBOR transition presents with the focus on finance, accounting, operational readiness, contract remediation and communication strategies. And then we will hear from Doug Dell, Doug Dell is a KeyBank middle-market sales leader. He's been with Key for over 15 years. He's an important part of the team helping us to address client perspectives, RM training needs, change management, coordination with partners across Key who interact and will interact with borrowers on this topic. He has counterparts from across other lines of business within Key, including our real estate group on the transition team. So without further delay, I will turn this over to Tony Bulic, thank you.

Tony Bulic

Okay, thanks Laurie. Thanks for the introduction. Good afternoon to everybody on the call and thank you for joining us and spending your time learning about this topic. So this first slide here we thought the best place to start would be to do a little level set and provide some background and make sure we're working forward from a good foundation. So the who, what, where, why around LIBOR transition. So first off on that item, that item list, what is LIBOR to do a quick refresher there? LIBOR what it's meant to be is to represent the rate at which one bank would lend to another bank. So a bank’s cost of funds - an unsecured rate between two banks. That's what it's supposed to represent. Now with that backdrop, you know, a long time ago that interbank offer at that interbank lending market was very active. And that was a very easy thing to see and an easy rate to put your hands on. Over time though, things changed, and it mainly in response to some regulatory requirements banks were required to hold a lot more liquidity cash on hand. So that activity in that interbank market really trailed off, so LIBOR became much more estimate based or judgment based. So it became an estimate of banks cost of funds or the rate they would lend to each other. And why that's important is because it became more estimate and judgment based, it was then more susceptible to manipulation. And unfortunately in the last credit crisis prior to COVID, that is anyway, that did occur and there was some scandals, large fines paid, some criminal convictions all around rigging LIBOR. So coming out of that, the reaction, so this gets to, okay, so what's going on with LIBOR now, and why, the FCA, which is the regulator for LIBOR basically said, hey, you know, given how LIBOR works now, and it's this judgment based rate or estimate based rate, we really don't think that's appropriate because what LIBOR does do is it underpins the world's floating rate instruments. So derivatives loans, trillions of dollars are underpinned by LIBOR. So they said, we can't have this. We're going to have to move from LIBOR to a more robust, transparent rate. And that's all fine and dandy. That's a good thing to aspire to, but how do you get there, right? And this gets into the when and how LIBOR goes away because of it being more judgment based and the scandals that happened around it, the Panel Banks, the banks that submit these submissions that form LIBOR, they really don't want to do it anymore because of the liability involved. They're being compelled to do so, and the FCA said, hey, what I'm going to do is say after December 31st of 2021, I'm no longer going to compel these banks to submit. So that's how we arrive at the date when we expect LIBOR to go away, which is that December of 2021 date. So that gets to the when. Now the one caveat I'll throw out there with the when is the FCA has been fairly vocal and saying, hey, we're the regular for LIBOR. If we get the sense that because of what's going on in this transitional way, that LIBOR becomes unrepresentative or unusable early, we reserve the right to end LIBOR early. So that caveat is there. But I think the expectation generally speaking is everyone is working towards that December of 2021 date. So that gets you a little bit of background on LIBOR, the why it's going away and how and when. Now what does that mean? What are the takeaways? The things to think about in reaction to that. One that I would throw out there initially is if you look at that December, 2021 date and say to yourself, hey, banks coming up to that, they're not going to want to make a new LIBOR loan a week before they think LIBOR is going to go away, because that means you're going to have to change the loan just a week later. So if you just carry that logic backward, that there is a time in 2021 where the industry, the lending industry is going to say, hey, we're not going to want to close any more LIBOR loans. Now we can argue about what that date is ARRC quote, and I'll get to what ARRC exactly is and their role in a second, but has thrown out a best practices recommendation of June 30th of 2021 to stop for example. And we can argue about what that date's going to be, but I'll say most things you read and hear are around, you know, call it July through September of that year, we would expect a majority of lenders just to pull back from the market in closing new LIBOR loans. So that's something to think about. And then you can back up from there as to when they'll stop pitching, right, and offering term sheets around it. So that's one takeaway. The next is, hey, if LIBOR is going away, we need something to replace it with. I mean, the floating rate, market's not going to go away. What are we going to do? And in general, people broadly believe that SOFR, a secured overnight financing rate is going to be the replacement for LIBOR, and I'll get through, you know, why it was chosen and sort of how we ended up there and give you some details on SOFR, in a second here, but that's the general takeaway and what I wanted to cover on this sort of level set page. Do you want to flip to the next one, Kelly? Now a couple of things before I proceed, and I think it's important that you understand who some of the players are and entities or organizations that you're going to hear about as we go through the transition in the upcoming months, ARRC, which I've mentioned already, and you'll probably, if you pay close attention to this topic here again and again, it stands for Alternative Reference Rate Committee, and ARRC was convened by the fed. And this is in response to this desire to replace LIBOR and they said, hey, we need to have an organized approach to transitioning and guiding the US market away from LIBOR. So the Fed convened ARRC, ARRC is made up of a number of banks, accounting firms, legal firms, tech firms, loan servicing firms. I mean, and anybody you would think of as involved in the LIBOR markets is involved in ARRC. And they put that membership together that group of participants, and then got about the business of thinking about what to do to transition away. So that's ARRC and their role. ISDA that you see on the right-hand side of the slide, think of them similarly for the derivatives market. So they're marshaling along the derivatives market in thinking about the different issues that need to be solved to transition away from LIBOR to SOFR. Now one real quick item, and I noted it on there. You see protocol referenced that that is just a term that describes how is that goes about implementing large scale change in the derivatives market. They set a protocol or standard way to move or fix derivatives for certain aspects. And in this case, it would be taking out LIBOR and inserting SOFR. So they have published their protocol as of October 23rd, and that's available and out there just to make you aware of that. So the takeaways from this side ARRC, ISDA, you're going to hear about them a lot, they're very involved, they help set conventions, they help make best practices recommendations for the industry and the like. And if you want to flip to the next side, Kelly. Now, getting back to, okay, LIBOR is going away. I mentioned SOFR is the likely replacement. Now, why did they pick SOFR and what is it? SOFR in very basic terms is the rate at which a borrower can borrow funding overnight secured by treasuries. So it's a repo, a repurchaser line overnight secured by treasuries. Now the two big takeaways there, it's overnight and it's secured by treasuries. So the treasuries aspect of that makes it risk-free. So that is an important consideration as I stepped through some of the details around SOFR and I compare and contrast it to LIBOR, that that'll become apparent and I'll hit on that again, but that's basically what SOFR is, it's a daily rate from a loan secured by treasuries. Now, why did they pick it. ARRC and is, you know, cycled through and said, hey, first, let's set some criteria as to what we want in a replacement index. And two of the biggies or primary factors were that it was deep, a deep market, and it was transparent. Now deep, that takes care of the issue of manipulation, because if it's a deep market, no one or two players can really push it around and manipulate it. So that's why they wanted a deep market and they wanted it to be transparent with a lot of transactions. So folks like yourself or other banks could look at it and see exactly what is making up the rate that that goes into my cost of funds. So when they laid out that criteria, believe it or not, there really wasn't that many indices because LIBOR was dominant that were available. And they settled on SOFR, which has trillions of dollars each day that's done in SOFR and quite a breadth of transactions. So it checks the box on each of those criteria. Now that's sort of why they picked it. I will make a point that this is a recommendation. So ARRC went through this process for the cash loan market. It's a recommendation by ARRC. There are other alternative indices out there that you might hear about from time to time in articles, new stories, whatever it might be. And things like Ameribor, BBY, which is a Bloomberg product, bank yield index, which is ICE as administrator for LIBOR has offered up. These are all alternative indices. They all have certain shortcomings and shortfalls that make them difficult as a broad replacement. For example, most of those are, I don't think any of those have active derivative markets behind them if folks were wanting to swap, for example. Now a little bit more about SOFR and how you can learn more about it, the Fed each day, if you were wondering where SOFR was at, the Fed each day publishes what the SOFR rate was from the night before. So at 8:00 a.m., what they would publish today at 8:00 a.m. would be the rate for yesterday's borrowing overnight. And they also publish a variety of averages that you can also reference 30 day, 60 day, 90 day averages, for example, on those daily rates so you can see how it moves over time. If you could flip to the next slide, Kelly. Okay, so we've now stepped through sort of that foundational on LIBOR into SOFR why we think it's the replacement, why it was chosen, learned a little bit about what it exactly is, that the next piece, this slide here we'll then step through how it's different from LIBOR. And that's important as we go through this transition, because those differences give rise to things we need to do in reaction or change about either how we think about deals or structured deals or fixed deals. So I'll step through these differences just to give you that perspective. So, first item on that list, just to reiterate, LIBOR is based upon submissions from the Panel Bank. So it's judgment based, has a lot of judgment to it. So when you look at historicals, it tends to be smooth because it has that human intervention to it. SOFR is based on actual transactions, very transparent, but because of that, we'll present a little choppier. And when I show you some actual data, I think that'll be fairly obvious. The next item, and this is a fairly material one, and I think I highlighted some of this even earlier. LIBOR is meant to represent the cost of funds for a bank at one bank lending to another and therefore it's unsecured a promise to pay if you want to think about it that way. And it has that credit risk component embedded into it, whereas SOFR, because it's secured by a risk-free instrument treasuries is risk-free. So risk-free versus a rate that has some risk in it. SOFR on average over time is going to be lower than LIBOR. And the takeaway there is, as we think about, or as you think about, hey, I'm looking at a deal that's quoted in LIBOR and a deal that's quoted in SOFR, you have to think about them a little bit differently because one is on average, a little bit lower than the other, or if you're going to fix a deal and you're going to say, hey, I need to take LIBOR out of this deal and substitute in SOFR, well, I need to take into account that SOFR on average is a little bit lower. So that's something that needs to be done there. So that's the takeaway there on difference. Now, stepping down, the next item is LIBOR has spent around a long time. It has, it developed forward looking term structure. And by that, I mean, it has, you know, an overnight rate, a one week rate, a one month rate, three months, and so on. All those different tenors or maturities are available every day. So it has that term structure and you just fix your rate for a period. You say, hey, I want to borrow money and it's a 90 day period, I fixed my rate for 90 days. SOFR on the other hand, and it's formed today is an overnight rate. So it doesn't have this term rate where you can fix it. Now, what I'll say on that topic is if you listen to the folks that are experts in derivatives and forward term rates and all that, what they would say is we firmly believe that a term rate for SOFR will develop over time, it's just a matter of when. And if you ask me to handicap it, what I'd say, what I read to pass that along is mostly around optimistic view, early second quarter. So April, May-ish to late third quarter, September-ish, you'll see most prognostications fall in there. Although there's some folks that would say and argue, you won't have a viable term rate till after cessation for certain reasons. So term rates, they will come. It's a matter of when. I think as time goes and we step through these next few months, we'll get more certainty as to how that's developing and the when will become that time range will narrow. Now, go stepping back to, hey, today it's a daily rate. LIBOR was this term rate, what does that mean? What's the takeaway? Well, if you just think about using a daily rate and your borrowing terms, so I want to borrow money for one month, if I'm using a daily rate, I don't know my rate to each day goes by, and I technically don't know my interest IO until the last day of the period. And in reality, we need some time to count the bill, send it out, collect on it, or pay it. So there's some operational things that we need time for, and we have to build that time. So if you think about it substituting SOFR, the takeaway is we need to do some things too. If it's an old deal we're fixing to make it usable, to use this daily rate and create some time, and the way folks usually handle it and what you see developing is convention in the commercial loan market is what they call a look back. And which is basically a shift of those observations. So for today's interest calc, I'll use the daily rate from five days ago, for example. So every rate will shift back five, and that would create five days of cushion at the backend to do all these operational things. So that's the takeaway there on the difference between LIBOR and SOFR. And then the last point that I would make on this page and why I put that in there is because of that risk component that's in LIBOR when you hit a stress so much like COVID, and on the next page I think I'll be able to show you some actual numbers where it really hit home, but when you hit a macro economic stress, what happens is there's a flight to quality and people, investors say, hey, until I figured this thing out, like when COVID was going on, till I figure this thing out, I'm going to move some of these funds over into treasuries into a risk-free instrument. And that causes risk-free rates just to plummet and fall because of that flight to quality. And SOFR being a risk-free rate is going to fall, in those kinds of macroeconomic scenarios, whereas LIBOR, it will fall with the absolute level of rates, but it's got that risk component in it and if investors are saying, hey, this is material enough and bad enough where I need to worry and really think through what's going on with banks, you'll see LIBOR spike for a period of time while that's being figured out. And that's where they'll divert, veer off from each other or in those large macro events. And I'll show you some history that sort of demonstrates that, but that's something just to keep in mind, A, when you think about the two versus each other, as well as when you look at history and you're wondering why this is happening, or should I be worried about it or not. So that was the last item on sort of the key differences and takeaways and how it might impact how you think about transition. Kelly, if you want to flip to the next one. So with that background, so we've stepped through sort of, hey, sort of what's going on with LIBOR, introduce SOFR, compared them, now where the rubber meets the road, you know, hey, what are the rates and how do they move versus each other, how they look versus each other. And this page here is it gives you that snapshot. And as you look at this real quick on what it's showing you, so it's one month LIBOR which I think you're all familiar with and then 30 day average SOFR and to be clear on that, I think an example makes it hit home. If I were to take the one month LIBOR rate that would set on March 1st of 2020, I would compare that to the average of each daily rate. So March 1st, second, third, all the way through the end of the month, average those daily rates and compare them to that setting at the first March. So that's what you're seeing on this page. So on the left, what you see there is what I like to think of is, you know, how do they move together? What's like the correlation kind of view, and you can see in general, they move pretty fairly well together. You know, they can go up and down around the same times, you'll see LIBOR looks a lot smoother. That goes back to the point I made around, hey, there's a human judgment factor to it. So it's got that smoothing built in and you can see where I highlighted at circle the spike in LIBOR where they sort of veered off from each other. And that's because of that phenomenon, the flight to quality and SOFR. That's right around COVID. COVID starts happening, rates are falling, LIBOR's falling with the level of rates. And then people say, oh, wait a minute, should I be worried about the banks, boom, LIBOR spikes up. SOFR continues to fall, Ffed steps in, people understand that a little bit better. And then they say, okay, no, I'm not worried about banks and LIBOR sort of snaps back in with SOFR. So that's up to you. On the right or middle table, that view just presenting that differential graph over time, you know, that LIBOR minus SOFR. And I like to think of that is what's the volatility of that difference between the two it's giving you that view. And you can see it's fairly stable, you know, bumps around a little bit when you look at scale, it's not all that much until we hit that COVID window and then you see that large spike again, and then snaps back down, and then on the right, just some stats where you can see, hey, how, why did they get apart? Hey, it was 99 basis points in the height of that COVID. COVID stress when people are trying to figure things out. And there was even instances where LIBOR was below. Those, I would say is probably more due to the forward-looking nature where one month LIBOR, people say, hey, I'm expecting the Fed to ease, so one month LIBOR will be a little bit lower because the expectation is built in. Whereas the daily SOFR, it moves when the Fed ease you get actual, if you want to think about it that way. So that's the numbers piece. This sort of just give you that picture of how they look versus each other the one, caveat I'll throw here, if you see other stats, et cetera, this was for the period of April 18 through October 20. So time periods do matter and how you look at these things. So that's what I had on the background around LIBOR and SOFR, and sort of giving you that foundation, I'm going to turn it over Jason Jurgens next, who's going to talk a bit about legal considerations and regulatory considerations. Jason, all yours.

Jason Jurgens, Jones Day

Thanks Tony, good afternoon everybody. My name is Jason Jurgens, as Laurie said at the top of the hour, I'm a partner with the law firm Jones Day. And our team has the privilege of helping both lenders and borrowers navigate the transition away from LIBOR. As Tony mentioned, KeyBank asked me to provide a brief overview of the relevant legal landscape, and then to touch on some of the risks that we're all grappling with in the context of LIBOR going away. So let me start with the legal landscape. There's three or four components to the legal landscape, I think that folks should keep in mind. The first is you have UK law and regulations coming out of London. As Tony touched on the FCA in London regulates LIBOR, and it's been doing so since 2013. And it was a speech by the FCAs then CEO, a guy named Andrew Bailey in July of 2017, that sort of set the LIBOR transition in motion. And the FCA has various powers related to LIBOR. It's currently seeking new ones from parliament, but I'm not going to go into those details. I think for those of us here in the US, there's one thing important to know about what the FCA is up to and, you know, and that's the fact that we're somewhat at the mercy of the FCA when it comes to LIBOR, particularly as it relates to timing. And I think Tony alluded to this, when will we know LIBOR officially gone? It's more or less when the FCA tells us. The second part of the legal landscape to keep in mind is state law, your loans, whether they're bilateral loans or syndicated loans, they're going to be governed by state law. Maybe it's New York, maybe it's Ohio, maybe it's some other state. So to interpret the relevant contracts, you're going to need to look to state law. There's also state regulators. They include attorney generals and banking regulators and regulators focused on consumer issues and regulators focused on small businesses. And so there's no shortage of regulators at the state level. The third piece of the legal landscape is a federal law at the federal level. Right now I believe to the best of my knowledge, there's only one federal law that actually references LIBOR and it relates to a particular student loan program, but of course, we're in America and we have a lot of federal laws and a lot of regulations that might apply. So we have to keep an eye on them too even if they don't mention LIBOR. And just a few examples. Well, what is the tax code say for example happens if we amend our contracts, there are some tax implications. Another issue has to do with guidance that some federal agencies may have issued. Does that guidance help us interpret contracts in some way? And these are just some examples of the questions that come out of what goes on at the federal level, and the federal agencies there. And of course you also have the federal reserve and an Alphabet Soup of banking regulators that are trying to ensure the safety and soundness of the banking system and they can't be ignored. And last but not least, a part of the legal and regulatory landscape that we have to keep in mind are sort of these international organizations that set international standards and organize financial regulators around the world, an example of that is the financial stability board. I just wanted to run through that really quickly to kind of sort of orient you to some of the legal issues and the landscape that's out there. But now that we've got the key contours of the legal and regulatory landscape, sort of sketched out, I wanted to talk a little bit about where we are today. And ironically, before I get to today, I want to go back to July 27, 2017. And that's when Andrew Bailey announced that everyone should expect LIBOR to go away at the end of 2021 as Tony mentioned. And, okay, given that we're talking about the London interbank offered rate and the FCA in the UK, maybe a cricket metaphor would be in order, but frankly, I don't know much about cricket, I'm a baseball guy. So let me try a baseball reference. If Andrew Bailey threw out the first pitch with his speech in July, 2017, that would put us today right in the middle of the seventh-inning stretch. So there's a few more innings left, right? But the game is almost over. So what's been going on for the last six and a half innings or so? After Bailey's announcement, the industry went through the stages of grief. First, there was denial. We heard lots of people saying there was no way LIBOR could go away, no way. There was some anger. How could the regulators do this to us? But by early 2018, there was some signs of acceptance, the ARRC, which Tony discussed, they began focusing on how to do new deals going forward. And again, that was new deals going forward, that took up a lot of their attention and for good reason, we needed to keep doing business, right? But by the spring of 2019, I think you saw the ARRC publishing guidance on how to document those new bilateral loans and syndicated loans. In fact, if you entered a new loan or refinanced in the last year or so, you probably have a loan that reflects the so-called amendment approach, which is based on the ARRC's guidance and while the ARRC and the LSTA too were busy working on new loans, is busy doing market consultations for derivatives. And there was really a lot of work going on. Both at the ARRC and individual financial institutions as well. But again, a lot of the focus was on new deals. And what items that remained on the to-do list for much of 2019 was legacy deals. In particular legacy deals that run out past 2021. And these legacy deals include a wide, wide variety of product types. You have the bilateral loans, some are relatively simple, others are more complex. You have syndicate loans, you have some loans with hedges, you have some that are secured. And of course, outside the commercial lending context, you have consumer products like student loans, mortgages, and you have securitizations and complex structured financial arrangements like RMBS, CDOs. And as I mentioned, you also have the Swaps. And again, there's this wide variety of products types that are impacted by LIBOR going away, and each has their own set of legal issues and risks. So what do you do to address these legacy deals? Well, the ARRC suggestion is legislation, specifically New York State legislation. Back in March, 2020, the ARRC put forward a legislative proposal, focused on contracts governed by New York law. And let me be clear this legislation concept, it's still an idea legislation hasn't passed, but I think it's important to understand a little bit about what the ARRC's legislative proposal looked like. There are three key elements. First, for transactions with no fallbacks or unworkable fallbacks, your contract would change by operation of law to the ARRC recommended rate, which will in all likelihood be some form of SOFR that'll likely vary depending on the product type. And the key there is by operation of law, which means you won't have to do anything if you want the ARRC recommended rate. Second, for transactions that provide a party with some discretion to select a new rate, there's a safe harbor against potential litigation claims. if you use the ARRC recommended rate. And third, if for some reason you don't want to use the ARRC recommended rate, you have the ability to opt out through a bilateral amendment. And that's what the ARRC's legislative proposal looks like. And this all sounds pretty good, right? But frankly, there's still a lot of uncertainties. There are political uncertainties. Will it ever pass? There are timing issues, when will it pass? There are substantive issues. What will the final law look like? How will it impact my contracts? Is there a chance that it won't for some reason, because of some decisions, policy decisions that wind up being made at the 11th hour? And then there's questions about scope. Again, the ARRC's focused on New York, because a lot of contracts are governed by New York law. The law will happen in other states, will they follow and pass something too, these are all some of the questions and uncertainties that are hanging out there. At the end of October, while we were preparing this presentation, the ARRC's legislative proposal was formally introduced in New York State at the Senate level, by a state Senator named Kevin Thomas. A week later, the state Senator who introduced the bill faced a tough challenge on election day. And as of today, he's behind. The local press, reported he was going to lose, but they're still counting absentee ballots in fact, under New York law, they started doing that today. So stay tuned, but if Senator Thomas loses, it's unclear what happens to the bill? Will it languish or not? But setting aside those uncertainties, there's also constitutional questions as well. I mentioned that the statute would alter contracts to reflect the ARRC recommendation. And there are quite serious constitutional questions about whether New York's legislature can effectively delegate responsibility for selecting a new rate to the ARRC. And at the federal level, there's some activity as well. Regulators are doing what they can to help some of the transition. You know, the IRS, for example, it's addressing tax implications and the CFTC they're addressing some issues related to Swaps. So they're trying to be helpful. And at the same time, the CFTC of course, is warning public companies and asset managers that they're watching closely to protect investors, which is all good, but there's also draft federal bills floating around on Capitol Hill now. Congressman Brad Sherman in California has a bill that he's socializing. It hasn't been officially introduced in the house. It's still very much a draft, industry groups are starting to weigh in, but the last draft that I saw, it looks a lot like the ARRC's proposal with one key difference worth noting. The difference has to do with the who selects the new rate. The federal bill, as in its current draft would effectively delegate that power to the Federal Reserve in the first instance, and the Federal Reserve could then delegate the power to the ARRC. So you sort of have the same political issues and some of the same constitutional issues, with the federal bill as you have with the ARRC's proposal. But let me wrap up my discussion of legislation with something of a public service announcement. Given all of these uncertainties that I noted, you really can't count on a legislative solution emerging. In fact, the general counsel of the Federal Reserve Bank of New York called it a hail Mary, and with all due respect to Aaron Rogers and Green Bay Packers fans out there, you probably don't want to count on a hail Mary. No, some of you may be sort of saying to yourselves, so what happens if legislation doesn't emerge, will there be litigation? Frankly, you may see litigation in the structured finance space. You may see it in the consumer space, but this is important. We don't foresee litigation in the commercial lending space. Let me just repeat that. We don't foresee litigation in the commercial lending space. Instead, what we see are banks undertaking amendment campaigns to address any uncertainties and resolve any ambiguities. It may mean that some banks have to amend tens of thousands of contracts. It might be painful for people like Tony and the KeyBank team, but the amendments should avoid the need for any litigation in the commercial lending space. So we can move to the next slide. So why do we need to amend the legacy contracts? The answer is somewhat simple. It's because of what they say, or in some cases what they don't say about what should happen if LIBOR goes away permanently. Remember when a lot of these contracts were entered, it was in some cases before July of 2017 and some were entered sort of shortly after then. And some of those contracts won't have any fallback provision at all. They'll be silent, why? Frankly no one anticipated LIBOR going away permanently. Some will have contract language that was designed to be used if LIBOR was temporarily unavailable. For example, imagine you get to a calculation date and LIBOR doesn't get calculated that day maybe it's because of a tech glitch or a power outage, or maybe it's a weather event, or God forbid a terrorist attack, whatever it is, there's an unexpected event that happens suddenly and LIBOR can't be calculated, but the expectation is LIBOR will be calculated again under those scenarios. You know, and there are contracts, legacy contracts that have provisions that say what you do in those situations, but the parties didn't intend to address what happens if LIBOR goes away permanently in most instances for those true legacy deals, those old deals. And that's an important distinction to keep in mind. We've seen dozens of variations of so-called fallback language. Some common examples are up on the screen in front of you. Each race has its own set of issues, including whether it was intended to apply in the permanent succession context or not. Was prime intended to be a permanent rate for example. Oh, what about a fallback provision that says that the rate will become the LIBOR rate that you use for the prior period? In that situation, you're floating rate loan would all of a sudden turn into a fixed rate loan, was that intended? You could see where there may be uncertainty. So how do you address the uncertainty? And the answer is amendments. And I just want to emphasize two things here really briefly. First it's important that we all get the amendments, right? When the amendment campaigns start. The worst thing that can happen is that you try to amend a contract and you make it unclear. So it's incumbent on borrowers and lenders alike to be careful when they're entering these amendments. But because banks are going to be trying to amend thousands of contracts, borrowers have to be particularly vigilant. They need to make sure the amendments work for their contract. And the second thing I want to emphasize is timing. Again, banks like KeyBank, they'll have thousands of contracts to amend. There'll be in touch. They'll probably send you an amendment, but don't wait to review it. If it works, don't wait to sign it. Imagine if every borrower waited until December, 2021 to review and sign their amendments, that would be problematic, right? If we could just move to the next slide and I'll briefly run through this. The next slide please. There we go. What I focused on so far were the legacy deals, this slide talks about new deals and the risks of new deals going forward. You know, your business is about to change, the way we all do businesses changing as we move away from LIBOR to SOFR. And let me state the obvious, any time you change the way you do business, risks can arise. There's some things to keep your eye on. How will switching to SOFR impact your business? It'll inevitably impact your financing arrangements, but what else, maybe it's your own cash flows, maybe it's your vendor agreements, maybe it's employment or consultant contracts that you have, or perhaps you're thinking about buying another company. Your diligence needs to include LIBOR exposure. As Tony mentioned, SOFR right now is a backwards looking rate. Terms SOFR doesn't exist yet. What does that mean for your business? How do you manage your cash flows? For those of you who may hedge, how will using SOFR impact your hedging strategy, whether it be basis risk. And finally, there are operational risks. You need to update your financial systems or models that might use LIBOR. These are some of the questions that everybody should keep in mind as we move through this transition. And with that, let me turn things over to Jeff Vitali for E&Y.

Jeff Vitali, E&Y

Okay, thank you Jason. Okay, so as mentioned in the beginning, I'm Jeff Vitali, I'm a partner in E&Y finance and accounting team. And Key asked me to come here today just to walk through what some of the accounting impacts and potential accounting impacts of this transition are. So on this slide, you'll see a fairly robust laundry list of some of the key items that may be impacted by the LIBOR transition. And I think a lot of these, you know, what we're seeing is some tangential impacts. And for the most part, a lot of the conversations in the industry have been focused around things such as contract modifications at the top, and then hedge accounting at the bottom. Contract modifications being a very important topic, just given the extensiveness with which the current accounting model would require an analysis of some of the amendments that are going to be made to certain financial instruments like loans, as well as derivatives. So there's the concept of taking any modification through what's known as a troubled debt restructuring test, and then assuming that the modification does not qualify as a troubled debt restructuring, then there's a requirement to do a quantitative 10% cash flows test for any type of loan that's being modified. And then on the corresponding side for derivatives, when a derivative is modified, the accounting guidance would require an entity to reassess whether the modified derivative still meets the accounting definition of a derivative, which means that the instrument needs to have a notional amount. It needs to have an underlying, there needs to be a mechanism to facilitate net settlement and then there needs to be no initial net investment in that derivative and that initial net investment test, especially with the interest rate environment where it is today could potentially cause some issues with the modification test, which would cause a derivative to be considered a financing arrangement rather than an actual derivative instrument. So we'll cover that in the next slide in a few minutes, but among these other items on here, a few that are a little more prospective looking, if you look at fair value measurement. So if you think of the fair value measurement concepts, one of the concepts that underpins any type of fair value measurement is how a market participant would view the key inputs into a specific valuation calculation. So one of the things that recently happened in the industry with the CCP discounting switch and that discounting now being done on a SOFR basis, that is a market event that may cause a change in valuation for instruments that previously might've used some sort of discounting mechanism to value derivatives based on either LIBOR-OIS. Now an argument could be made that that valuation methodology would need to be changed so that the discount rate used in the instrument should actually be based on SOFR because that's what the central clearing parties are using. So that's a consideration. And then more forward-looking once we get more rapidly, get into the transition period at some point next year, when SOFR volumes are increasing and LIBOR liquidity and LIBOR volumes are increasing, decreasing, excuse me, there could be an inflection point where your legacy LIBOR based instruments are now no longer being quoted in quite as active and market as they are today. So the implication of that is instruments that are not being quoted in active markets or instruments that are being quoted in markets that aren't necessarily liquid enough, they may not qualify as a level one financial instrument. They may qualify as a level two instrument, or if you're making certain valuation adjustments to compensate for that lack of liquidity, may actually qualify as a level three financial instrument. So within the fair value hierarchy of levels, one, two and three, as well as the fair value methodologies that you use, there could be some impacts related to this transition from LIBOR to SOFR or other alternative reference rates. Moving a little further down when we come to interest income and expense calculations, it's a very similar concept in that when you talk about interest accruals that are being made on either securities or loans or other positions, those interest accruals are not always based off of the stated interest rate in the contract, they're based off of the effective interest rate. So that effective interest rate is calculated using cashflow projections being discounted back to the present value of the instrument at the time of the calculation. So that effective yield may be impacted and may be required to be updated based on any instrument transitioning from LIBOR to SOFR. And then lastly, on this slide, before we move on to the next one with hedge accounting, both given the potential timing mismatch between when a loan and a derivative might transition and also product convention mismatches that may occur where you could have a derivative transition to SOFR calculated based on compound interest in arrears. And you could have a loan transition, that transitions based on SOFR for example, simple average and arrears. Those types of timing mismatches and convention mismatches could theoretically create some P&L volatility that would need to be addressed. Now, in spite of all this, if we move to the next slide, now, there has been some relief guidance provided by the FASBI here in the US which is a positive thing. So a lot of those items that we're talking about on the previous slide, they're absolutely still applicable, but some of them, you may be able to apply relief guidance to if certain gating criteria are met. And those gating criteria essentially established that if modifications are being made to contracts that are solely related to reference rate reform, then you can essentially just account for any impact or any change on a prospective basis. So if we jumped to the next slide to give an example of this, so a change that's considered related to reference rate reform, you're talking about things like the interest rate index, you're talking about changes to different reset periods, reset dates, day count conventions, changes to strike prices of an existing option that exists in an instrument and if the modifications being made fit within those gating criteria, then all of those tests that I was talking about for contract modifications, you don't need to do any of them. You can actually account for the modification prospectively. Similarly for derivative, if the only modifications being made are those that generally would fall into the left-hand column here, you don't need to reperform the initial net investment test, you can count for that derivative prospectively. For hedge accounting it's very similar where all of those potential impacts due to the mismatches in timing or product conventions would not have an impact on the effectiveness of your hedge relationship. So you could still assume that there's perfect effectiveness. So it's a very key set of relief guidance that was provided by the FASBI. Now on the right-hand column, when we talk about changes, unrelated to LIBOR reform, if terms such as notional amounts, maturity dates, any type of concessions being granted in the contract occur, those are amendments that are not considered to be related to reference rate reform. So if any amendments occur here, then what happens then is you're essentially disqualified from the relief guidance, and you need to apply all of those tests and really apply the full scale of the accounting guidance to any type of modifications that are being made. So definitely in terms of level of effort, it's important to stay in the left column as much as possible. So now just moving on, we have an example on the next slide of the initial net investment test, I think for the interest of time, given we're running a little bit behind, we'll skip over this slide here, but this just gives an example of how that test is done, and the objective of the test, which is essentially boils down to you have to compare the fair value of your swap or your derivative at the time of modification to the present value of the fixed leg of an at-market swap post modification. And if that ratio is greater than 85%, that's when a derivative is considered to be a financing. But again, if you're only modifying terms related to reference rate reform, you can avoid this test. So this test would only be triggered if you're falling into that right-hand bucket on the previous page. And then just real quick on the last slide before we move on in regards to hedge accounting as I indicated in the beginning, for cash flow hedges and any term type of critical terms match, if you're only amending items in the left-hand column related to reference rate reform, you can essentially disregard any ineffectiveness that would be created in the instrument. For fair value hedges, you would need to account for the incremental P&L that's generated in some way, either recognize it immediately in P&L or amortize it over the remaining life of the hedge adjustment, but that's not a penalty, that's just following normal fair value hedge accounting. If you fall on the right hand bucket and you start modifying notional amount maturity date, other terms, then you're going to have to reassess effectiveness, and you may potentially disqualify yourself from some of your hedge relationships. So I'll stop there, and I think we can move on. Doug, I'll hand it over to you.

Doug Dell, KeyBank

Very good, well, thank you, Jeff. I'm from KeyBank. I run the middle market group for Colorado. So happy to be talking to you all. I think in the interest of time, the first slide that we had here was really about the scope of the project, and I can tell you it's been big. 20,000 contracts to look at, 3,500 swap contracts that complicate it. So it's been a massive undertaking. What I do want to part on this slide is that we know that client communication and transparency is critical, especially when it comes to changes that could impact your interest cost and billings. So I just, I want you to be assured that we will continue to keep you updated as the process moves forward. Kelly, why don't you move over to the next slide. So wanted to make sure we got in what you should expect next and what you should be aware of as we go through this change. So number one, KeyBank is ready to originate SOFR based loans beginning soon after, soon in the fourth quarter of 2020. So if you decide to renew your LIBOR based loan with a SOFR rate, you will not need to go through the amendment process. Any LIBOR based loans that mature after December of 2021, will need to be amended with a SOFR rate if it's not addressed earlier. So in the middle market, since we have so many contracts to address that, that do mature after December of 2021, backed, I think there's about 20,000, we have opted for efficiency. So KeyBank has developed artificial intelligence tools to comb through its loan portfolio to produce an appropriate amendment document for many of its loan products. We're working with Jones Day we've met on this call. We have created automated amendment documents for the change. So we'll begin that process in the first half of 2021, your relationship manager will be in contact when it's time for you to address your loan document. We have both clients from our commercial banking group and from our income property group on this call. So unlike commercial banking, the income property group and the CDLI, which is Community Development Lending and Investment group, they've taken a little different approach. They will largely involve the use of outside attorneys to address amendments for their loans rather than the kind of automated process that the commercial banking was going through. The income property group tends to have fewer but larger more complex transactions than we do in commercial banking. Kelly next slide. So I wanted to, well, from a class perspective, I'm sure the topic of how will my all in interest rate be affected by the switch to SOFR is one of the most important aspects for us all to talk about. So in determining SOFR, a SOFR based interest rate, there's going to be two separate paths, one for LIBOR loans that will be amended with a SOFR rate, and then second for new loans that we will originate with the SOFR rate. So for those existing loans that require LIBOR to be replaced, an index spread adjustment calculated and agreed to by both ARRC and ISDA will be added to the SOFR index to make the rate more consistent with LIBOR. Your loan margin, or your spread over the adjusted index will remain the same as if it was for your previous LIBOR loan. So the equation will read, your SOFR index, plus that index spread adjustment, and then add added to that will be your existing LIBOR spread. That index spread adjustment will be determined on the cessation date of LIBOR based on the five-year average of the difference between LIBOR and SOFR. That adjustment will not change over the remaining life of the loan. For new loans that use a SOFR index, there will be no adjustment factor. Instead, the spread or margin over the adjusted SOFR index, which is typically lower than LIBOR, will be adjusted somewhat higher to recognize the risk differential between LIBOR and SOFR. Tony talked about that earlier. The interest rate equation then is just the SOFR index, plus the new spread over SOFR. Again, the intent is to keep your all in interest rate consistent between the two indexes. As you heard that the switch to SOFR will cause billing changes. With LIBOR, we had the forward-looking term rates for 30, 60, 90 days, so you knew your interest rate before the end of the period and the bank had produced an invoice before the end of the month for timely payment. With SOFR, for the time being, we only have a daily rate. So the bank will not know the interest rate for the final days in the period before it needs to produce that invoice. To allow for timely billing and payment, bank will use what is called a look back method, which applies the daily rate in arrears for say five days before the current days balance. That will allow the bank to cut the invoice off and bill before month-end, allowing time for prompt payment. Our loan systems have been updated to accommodate SOFR interest calculations and billings. And of course, as always, your relationship team will be available to address any questions as you adjust to this new format. So Kelly, I'll turn it over to you to wrap up.

Kelly Eckels, KeyBank

All right, thanks a lot Doug. I really appreciate it. So we're coming up on the top of the hour. So just a couple things we wanted to cover real quickly before we wrap up here. On this final page, you're going to see some additional resources we have available. So first off, on Key's web webpage, there's going to be a host of information you can find where it relates to the LIBOR transition. So you can access that at key dot com backslash LIBOR. So anyone can go out there and pull that information down. Additionally, on this page, you'll see a few other links to external resources such as the websites for ARRC, ISDA and the Loan Syndications and Trading Association. And then lastly, as I mentioned at the top of the hour, we do have email address that we've created, so we can follow up with any questions you might have either based off the webinar today, or future questions that you might have. So that email address is LIBOR underscore transition at KeyBank dot com. So this email address can be found also on the Key dot com backslash LIBOR page. So if you scroll to the bottom of that key dot com page, there's a frequently asked questions section, and you can find information there and the link to the email addresses there. Again, that's LIBOR underscore transition at KeyBank dot com. Our communications team will be monitoring that email box and we'll direct any questions that we've received through that email box to the appropriate party for response back to you. Also, as we wrap up, if you're interested in getting a copy of this presentation we went over today, please reach out to your KeyBank relationship manager or banker, they'll be happy to assist and get that over to you. So at that, I just wanted to take a second to thank our speakers today for sharing their insight with us, and then of course, thanks to all of you for joining us today as well. And with that, the webinar's concluded, everyone have a great rest of your day. Thank you very much.

Fundamental change is coming to the floating rate loan market. After more than 40 years, the London Interbank Offered Rate or LIBOR – the benchmark index by which major global banks lend to one another – is being phased out by the end of 2021. The index primed to replace it, the Secured Overnight Financing Rate or SOFR, is more reliable and secure. The transition has implications for lenders, borrowers, regulation, legality and accounting, for both existing contracts and new ones. The good news: preparation has been long underway to ease the change.

From LIBOR to SOFR: Understanding and Easing the Index Rate Transition in Lending

Experts from KeyBank, Jones Day and Ernst & Young held a discussion about the LIBOR wind-down, why it is happening and what clients should expect over the next year.

Participants were:

  • Anthony Bulic, Senior Vice President, Securitization, Hedging & Analytics, KeyBank
  • Jason Jurgens, Partner, Jones Day, Financial Markets Practice
  • Jeff Vitali, Partner, Ernst & Young, Financial Services Practice
  • Doug Dell, Middle Market Commercial Sales Lead, KeyBank

The Why and When of the LIBOR Transition

LIBOR was established as the benchmark index when the interbank lending market was very active. However, in response to a regulatory environment that required banks to hold more liquidity, the volume of unsecured bank debt market activity slowed considerably. LIBOR was calculated by submitted estimates from panel banks. Bulic explained that as LIBOR became more estimate-based and subjective, it was more susceptible to manipulation, which occurred during the financial crisis.

With LIBOR no longer a reliable benchmark, the United Kingdom-based Financial Conduct Authority (FCA), which oversees the rate, announced it will cease compelling banks to continue to submit rates beyond 2021. Bulic notes that although the financial industry is working toward a transition date of December 31, 2021, the FCA has indicated that if LIBOR becomes unrepresentative early, it reserves the right to end earlier. Most experts believe that the lending industry will stop closing LIBOR loans sometime between July and September of 2021.

LIBOR’s Expected Successor: SOFR

With the floating rate loan market not going away, the financial community was in need of a move from LIBOR to a more transparent and robust rate. In anticipation, the Alternative Reference Rate Committee (ARRC) was convened by the U.S. Federal Reserve, comprising stakeholders including banks, accounting firms, legal firms, technology firms and loan servicing firms. The ARRC and the International Swaps and Derivatives Association (ISDA) set the criteria for the replacement benchmark – a deep market and transparent rate calculation. Bulic notes that a deep market was key to prevent manipulation.

The selected replacement benchmark, SOFR, represents the rate at which a borrower can borrow funding overnight secured by treasuries. SOFR is used for trillions of dollars of deals each day, representing a vast breadth of transactions, so it “ticks the box” of being a deep market, according to Bulic. Each day, the Fed publishes the SOFR rate from the night before and also publishes a variety of averages over time ranges, making it transparent as well.

LIBOR and SOFR are different in two primary ways that will impact how the lending industry will structure deals. First, LIBOR is based on submissions from the panel banks and because of that human intervention, is very smooth. SOFR, on the other hand, is backward-looking and based on actual transactions so it can be choppy. Second, LIBOR is unsecured, so it has a credit risk component. Conversely, SOFR is risk-free because it’s secured. Those differences mean that on average SOFR is lower than LIBOR.

In addition, because LIBOR has been around a long time, it has a term structure, but because SOFR is an overnight rate, it does not have a term rate. Bulic says lenders believe a term rate for SOFR will develop over time.

Because LIBOR moves in anticipation of the Fed acting, while SOFR moves in response to the actual, it is easy to see how SOFR and LIBOR diverge when a significant macroeconomic stress – such as the COVID-19 pandemic – hits the market.

SOFR vs Libor Historical and Current Divergence

What Are the Regulatory and Legal Ramifications?

The scope of the LIBOR transition means regulatory bodies at every level will be involved. Jurgens outlined the legal landscape that will guide the process. The FCA, which regulates LIBOR, will continue to set the timing, he says. In the U.S., loans, whether bilateral loans or syndicated loans, are governed by state law and state regulators focused on banking, consumer issues and small business. On the federal level, while there is only one law that actually references LIBOR specifically, many regulatory bodies are involved in the banking industry, and other regulations, such as the tax code, need to be considered in loan contracts.

Jurgens says that when the FCA’s Chief Executive Andrew Bailey first announced that LIBOR would cease, it rattled the market and many believed it wouldn’t come to pass. However, by 2018, acceptance had set in and by 2019, the ARRC and ISDA published guidelines on new bilateral and syndicated loans.

However, financial organizations still had to contend with legacy deals in a variety of product types, including commercial loans and interest rate swaps, consumer products such as student loans and mortgages, and securitizations and complex structured financial arrangements like mortgage-backed securities and collateralized debt organizations. A wide variety of product types are impacted by LIBOR going away, and each has their own set of legal issues and risks. The question became, “What do you do to address these legacy deals?”

The ARRC proposed legislation, focused on contracts governed by New York state law. The proposal outlined that for transactions with no fallbacks or unworkable fallbacks, the contract would change by operation of law to the ARRC recommended rate, which would likely be some form of SOFR. Second, for transactions that provide a party with some discretion to select a new rate, there's a safe harbor against potential litigation claims if you use the ARRC recommended rate. And third, parties have the ability to opt out of the recommended rate through a bilateral amendment. The ARRC assumed that if New York State adopts the law, other states will follow suit along similar lines. At the same time, drafted federal bills are attempting to address the same issues.

However, political uncertainty about reaching an agreement and constitutional questions about how legislation delegates responsibility mean that a legislative solution is not likely. Jurgens instead says contract amendments will be needed to eliminate legal and pricing risk.

“We don’t foresee litigation in the commercial lending space, instead we see banks undertaking amendment campaigns to address uncertainties,” he said. The contracts need to be amended because when they were entered, some didn’t have any fallback provisions or temporary fallback measures because no one anticipated LIBOR going away permanently.

In looking at new deals, the move from LIBOR to SOFR will bring changes in how we do business, and those changes can bring risk. Switching to SOFR will inevitably impact financing arrangements, but it may also impact cash flows, vendor agreements, employment or consultant contracts, and pending acquisitions. Jurgens urges companies to consider how using a backward-looking rate such as SOFR changes how you assess cash management. For companies that may hedge, SOFR will impact their hedging strategy. And to prevent operation risks, companies should update financial systems or models that use LIBOR.

What Are the Accounting Implications?

The extensive contract modifications that need to be completed carry with them significant implications for accounting. Vitali explained that the current accounting model would require an analysis of loan amendments through various accounting tests, such as the troubled debt restructuring test, fair value measurement, impairment input, interest income calculation, compensation and benefits and hedge accounting.

For example, Vitali pointed to fair value measure. As the transition accelerates next year to where SOFR volumes are increasing and LIBOR liquidity and LIBOR volumes are decreasing, there could be an inflection point where legacy LIBOR-based instruments are now no longer being quoted in as active and liquid a market as they are today, so they may not qualify as a level-one financial instrument. So within the fair value hierarchy of evaluation, there could be some impacts related to this transition from LIBOR to SOFR.

However, the Financial Account Standards Board has issued some relief guidance that if certain gating criteria are met, the accounting tests for contract modifications do not have to be done. Vitali notes that in essence, the gating criteria established that if modifications are being made to contracts that are solely related to LIBOR reference rate reform, then you can account for any impact or any change on a prospective basis.

Related to Libor Reform

What You Can Expect from KeyBank During the Transition

As complex as the LIBOR transition is for the lending industry, borrowers should take heed that financial institutions are preparing to make it as smooth as possible for them. Dell says that KeyBank is evaluating more than 20,000 contracts and 3,500 swap contracts, with client communication and transparency at the forefront, particularly when it comes to changes that could impact your interest cost and billings.

KeyBank is ready to originate SOFR-based loans beginning in the fourth quarter of 2020. Borrowers who decide to renew their LIBOR-based loan with a SOFR rate will not need to go through the amendment process. Any remaining LIBOR-based loans that mature after December 2021 will need to be amended with a SOFR rate. To make the process more efficient, KeyBank has developed artificial intelligence tools to identify loans that need to be amended and produce appropriate amendment documents. This process will begin in the first half of 2021 with outreach from your KeyBank relationship manager. For clients of the income property group or Community Development Lending and Investment group, the process will be a more hands-on legal review rather than automated.

For determining a SOFR-based interest rate, clients should expect two separate paths: one for LIBOR loans that will be amended with a SOFR rate, and another for new loans originated with the SOFR rate.

  • For existing loans, an index spread adjustment will be added to the SOFR index to make the right more consistent with LIBOR. Your loan margin, or your spread over the adjusted index, will remain the same as if it was for your previous LIBOR loan. That index spread adjustment will be determined on the cessation date of LIBOR based on the five-year average of the difference between LIBOR and SOFR. That adjustment will not change over the remaining life of the loan.
  • For new loans that use a SOFR index, there will be no adjustment factor. Instead, the spread or margin over the adjusted SOFR index, which is typically lower than LIBOR, will be adjusted somewhat higher to recognize the risk differential between LIBOR and SOFR. The interest rate equation is the SOFR index plus the new spread over SOFR.

For billing, since SOFR is a backward-looking rate, the bank will use what is called a look-back method, which applies the daily rate in arrears for a set period before the current day’s balance. This will allow for timely billing and payment on a set schedule.


The move from LIBOR to a stronger, secure and more reliable rate has been a long time coming, but it will require a coordinated effort to amend legacy LIBOR-based contracts and begin closing new SOFR-based deals throughout 2021. The lending industry and legal and accounting firms that service it are all focused on making the transition as turnkey as possible for clients, and regulatory and oversight agencies are guiding the way.

For more information on how the LIBOR transition impacts your business, please contact your KeyBank relationship manager.

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