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.
Interest-rate options at Truist
|Index||Terms (tenors)||Interest rate structure|
|Term SOFR||1, 3, 6, and 12 month||Set in advance at commencement of the interest period|
|Average SOFR||30, 90, and 180 day||Set in advance at commencement of the interest period|
|Daily SOFR||Overnight||Averaged daily throughout the month|
|BSBY||Overnight and 1, 3, 6, and 12 month||Overnight BSBY fluctuates daily based on the rate that day; for other tenors, rates remain the same over the interest|
For more information about each of these rates and the version process, check out Moving on from LIBOR on the Truist Resource Center.
As the post-LIBOR era continues to take shape, we’re seeing the same complexity of different lenders preferring different indices that we witnessed decades ago before the market settled on 1-month LIBOR as the preeminent benchmark. The process will likely be the same for SOFR—we just need time for the market to settle around the most compelling benchmark. While 1-month Term SOFR seems to be the leading alternative, it’s still too early to tell.
What happens to my loans?
There are different scenarios depending on when your loans originated or will renew. If you have a swap or hedge in place, the benchmark shift will affect your swap as well.
The ARRC governs the LIBOR conversion, and the International Swaps and Derivatives Association (ISDA) regulates swap and hedging transactions. As the June 30, 2023 regulatory deadline approaches, Truist is working with its clients to devise the easiest and most transparent method to convert to the new benchmark for existing and new loans/swaps, regardless of maturity.
The LIBOR sunset and SOFR/BSBY arrival present a good opportunity for a strategic capital review. Mapping the conversion to the new reference rates, reviewing existing loans, considering new debt, and thinking about the impact of a rising rate environment makes now the ideal time to engage your Truist Dealer Services relationship manager. Look to hear from us in the coming months as we move your credit facilities the latest rate benchmarks.
How’s your dealership positioned for the transition from LIBOR?
With the LIBOR sunset and a rising rate environment, now’s the time to talk to your Truist Dealer Services relationship manager about a strategic capital review.