Pub. 13 2018-2019 Issue 6

NEBRASKA BANKERS ASSOCIATION 13 Counselor’s Corner — continued on page 14 Knowing the scope of your bank’s LIBOR exposure with regard to contracts and assets with maturities beyond 2021 is the first step. have entered into LIBOR-based financial contracts or that otherwise originate, own or service individual home mort- gages, commercial loans, consumer loans, student loans or other LIBOR-based assets should catalogue LIBOR provisions in their documents, now. Banks should consider the following: • LIBOR-based. Which contracts rely on LIBOR? • Fallback Provisions. What, if anything, do the docu- ments say about the use of alternative benchmarks if LIBOR becomes unavailable? - If there are alternatives, what is the alternative rate? - If there is more than one alternative, who chooses (lender or borrower)? - Is an adjustment to the spread to LIBOR provided for? • Has the Fallback Provision Been Triggered? Does the contract incorporate a test to determine whether LIBOR has ‘died’ or is no longer available? Who determines when and whether the alternative benchmark should be used, and on what basis? • Amendment Provisions. When and how may the con- tract be amended (if a change is desired)? There may be vast, or minor, differences in these provisions. Identifying and evaluating with precision the relevant provisions in existing contracts and assets referencing LIBOR is critically important to confronting any challenges relating to the potential end of LIBOR. Existing LIBOR-Based Contracts The phase-out is especially thorny for “legacy” contracts (existing contracts which reference LIBOR and that will remain in effect beyond 2021). Many legacy contracts lack provisions addressing what happens if LIBOR is no longer published. The contracts that do, fail to fully address the issue as they were drafted for the possibility of only a temporary interruption in LIBOR’s availability. Few contracts drafted prior to 2018 contain provisions which completely and precisely address the current LIBOR question. Conceptually, many of the LIBOR concerns could be ad- dressed by amendments to legacy contracts. 4 Amendments to bi-lateral contracts will be a function of the relative leverage of each of the parties. The risk of dispute will likely depend on whether, among other things, the parties believe that a LIBOR- based rate and the currently specified margin would be higher or lower than the alternative that would be put in place. Certain Document Issues The biggest potential problems relating to legacy contracts (many applicable to new contracts too) concern trigger provi- sions, the fallback-benchmark rate provisions, and the margin (or spread) provisions. Risk arises when these provisions are ambiguous or authorize someone to exercise discretion. Trigger Provisions Trigger provisions are the contractual terms which determine when LIBOR no longer governs. Often they are clear but some- times are not. The less clarity as to when LIBOR is no longer applicable for determining the interest rate in a contract, the greater the likelihood of a dispute. • Many trigger provisions are clear – for example, pro- viding that a specified LIBOR rate applies as long as it is published by an identified source such as The Wall Street Journal. • Other trigger provisions are ambiguous – for example, stating that a fallback rate can be selected when LIBOR “is no longer a widely recognized benchmark rate”. • Some legacy contracts have no trigger anticipating the end of LIBOR. In such cases, if and when LIBOR ceases to be published, a party could argue that the contract is missing an essential term and is, therefore, no longer enforceable. • What if LIBOR was nominally available, but the FCA used its supervisory power to declare that LIBOR is unrepresentative of the underlying market? Would the provisions be triggered? Fallback Provisions Fallback provisions identify an alternative index that applies after the trigger occurs. Even where legacy contracts contain fallback provisions, such provisions may be ambiguous or may be otherwise vulnerable to challenge on the grounds that the parties anticipated the fallback as a temporary stop gap in case of a temporary interruption in LIBOR and not as an alternative index for the term of the contract. • Some fallback provisions refer to rate quotations ob- tained froma specified number of “reference banks,” but do not provide for the potential that quotes are no longer provided by the number of banks the parties anticipated when they entered their contract. • Some fallback provisions refer to “comparable” indexes, which requires the bank to exercise its judgment as to comparability (creating a real possibility of disputes). • In some legacy contracts, if LIBOR becomes unavail- able, the fallback provision converts the contract to a fixed rate using the last published LIBOR. Disputes may arise as to whether such fixed rate was intended only as a temporary stop-gap (in case of a temporary interrup- tion in LIBOR), not a permanent rate for the contract’s entire remaining term.