Brandon Artigue is Director for Truist Securities, and Brian Frank is Senior Vice President for Trust Dealer Services.
The sunset of the London Interbank Offered Rate (LIBOR) has been in the works for years, and commercial businesses like auto retailers have been awaiting details on the transition to its replacement.
In March of 2021, the Financial Conduct Authority (FCA) in the UK announced the dates that it would stop publishing LIBOR in favor of a more transparent, market-driven benchmark. Starting January 1, 2022, banks no longer had the option of using LIBOR as a benchmark for new or renewed credit facilities, but rest assured, on existing loans 1-month LIBOR will continue to be published and used until June 30, 2023. That gives borrowers and banks over a year before the deadline to put plans in place to move to a substitute index.
With its endorsement by the Alternative Reference Rate Committee or ARRC, Secured Overnight Financing Rate (SOFR) appears to be a leading successor to LIBOR. The Bloomberg Short-Term Bank Yield Index (BSBY) has also emerged. Truist is closely watching the development of all the market’s reference rates.
Dealerships shift from LIBOR.
LIBOR has been the primary benchmark used for retail dealership loans, including floor plan inventory lines of credit, commercial real estate, and blue-sky loans, with a handful of OEM loans priced based on prime rate. As loans renew or new loans are made between January 1, 2022 and June 30, 2023, they will be based an alternative index such as SOFR. Consistent with the recently passed Adjustable Interest Rate (LIBOR) Act, existing LIBOR-based loans expiring after June 30, 2023 will convert to the new benchmark, either following automatic provisions already in place within those loans or by modification before that date.
Each lender—including Truist—will devise its own plans to convert existing loans to the new benchmark. Truist is working on a conversion process to make the benchmark shift as straightforward as possible while not materially impacting all-in interest rate levels.
Settling into SOFR and BSBY
As the SOFR standard is developing, several variations of SOFR—Term, Average, Daily—have surfaced. All of the variations are calculated based on actual, settled transactions within the short-term borrowing markets. Term SOFR is forward looking, like LIBOR, while Average and Daily SOFR are backward looking. The other leading alternative index, BSBY is forward looking in all its variations.
A key difference between SOFR and BSBY is its relative sensitivity to credit risk in the market. SOFR is closer to a ‘risk-free’ rate—since it’s calculated using overnight lending with high quality collateral—while BSBY has a credit risk component since it aims to represent unsecured lending by design. In normal markets, you’d expect SOFR to be a lower interest rate than LIBOR or BSBY, and that has largely held true historically.