Pub. 13 2018-2019 Issue 6

WWW.NEBANKERS.ORG 12 COUNSELOR’S CORNER LIBOR: Birth, Growth and Probable Death Jeff Makovicka, Kutak Rock LLP N 1969,MINOSZOMBANAKIS,AGREEKBANKERBASEDINLONDON,SOUGHTTOCONSTRUCT an $80 million loan to the cash-strapped Shah of Iran at a time when interest rates were highly unstable. To achieve this, he looked beyond the traditional bondmarket to identify an alternative source of capital. Bymarketing the loan to a syndicate of banks (one of the very first syndicated loans), Zombanakis funded the loan with rates based on the participating banks’ funding costs. The weighted average plus spread for profit, became the rate on the loan for the next period. And so the London Interbank Offered Rate (“LIBOR”) was born. 1 LIBOR is often dubbed “the world’s most important number” and is perceived to represent the average interest rate at which banks can borrow from one another. To calculate the rate, individual banks submit their estimates of the cost to borrow that day to the ICE Benchmark Administration, which in turn excludes the upper and lower quartiles, then averages the rest to get LIBOR. This is all regulated by the U.K.’s Finan- cial Conduct Authority (“FCA”). Sixteen or fewer banks submit rates for LIBOR in each currency. This sounds straightforward, but in applicationLIBORhas flaws. LIBOR submissions are informed by only a small and dwindling number of actual transac- tions, making them less representative of what is actually occurring in themarket. A declining volume of transactions—driven by long-term changes in bank funding patterns—means that most of the daily figures that banks give the ICEBenchmark Administration are simply judgment calls, and are not based on actual transactions. This reliance on judgment calls, according to the New York Fed, increases LIBOR’s vulnerability to manipulation. 2 These flaws have made public and private sector institutions increasingly concerned about LIBOR. Responding to these growing concerns, several institu- tions have decided to stop providing LI- BOR submissions to the ICE Benchmark Administration. As the number of LIBOR submitters declined, the FCA announced that it had forged agreements with banks to continue submitting rates through 2021, but that “the survival of LIBOR… could not and would not be guaranteed” after that. 3 Since 1969, LIBOR has been the reference rate for hundreds of trillions of dollars in financial contracts, rang- ing from syndicated loans, floating rate bonds and notes, to individual home mortgages, commercial, consumer and student loans, and other simple and complex debt financings. Many lenders are busy preparing for the post-LIBOR era – which is widely expected to arrive on January 1, 2022, when LIBOR as we know it may pass away. Preparing for the Phase-Out Knowing the scope of your bank’s LIBOR exposure with regard to con- tracts and assets with maturities be- yond 2021 is the first step. Banks that