Regional Banks Face Bumpy Road Away From Libor
December 04 2019 - 8:29AM
Dow Jones News
By Daniel Kruger and Allison Prang
Regional banks are struggling to move away from the troubled
London interbank offered rate, saying alternatives to the key
benchmark for variable-rate debt could hurt their ability to make
new loans.
Those banks, including PNC Financial Services Group, Regions
Financial Corp. and U.S. Bancorp, say they are concerned the new
secured overnight financing rate, or SOFR, could notch outsize
drops at times of economic stress. That could force banks to lend
at low rates at times when their own borrowing costs are
rising.
Preparing for the shift is critical because regulators in the
U.K. overseeing Libor have said they won't ask banks to continue
participating in the rate after 2021. Libor was discredited about a
decade ago after a manipulation scandal led to billions of dollars
in fines for banks and prison sentences for traders.
Now regulators and bankers are seeking a new rate to underpin
trillions of dollars of financial contracts for everything from
home mortgages to company credit lines. Banks, companies and
investors all want a rate that reflects the risks from short-term
lending, is supported by a liquid market and behaves in a
predictable manner. Properly setting lending rates can determine
whether loans are affordable for borrowers and profitable for
lenders.
In the U.S., the transition to SOFR is being guided by a
committee of Wall Street banks and investment firms convened by the
Federal Reserve. The shift to SOFR is particularly thorny for
banks, which make money by acquiring capital at low cost and
lending it at higher rates. That is because SOFR is derived from
super-safe U.S. government borrowing rates, which are essentially
guaranteed to be lower than the rates at which banks can
borrow.
Additionally, some bankers expect rates on variable-rate loans
linked to SOFR to decline at times of economic stress, right when
it typically becomes more expensive for banks to borrow. In a
growing economy, Libor tends to be modestly higher than SOFR. Banks
are worried that the difference will widen during a slowdown, as
investors will rush into the relative safety of government debt,
dragging down yields, while avoiding riskier corporate bonds,
pushing those yields higher.
The committee concluded that "there was no way to bridge the
gap" between Libor's sensitivity to credit risk and the reliability
and depth of the repo market that underpins SOFR, said David
Wagner, a senior adviser at Houlihan Lokey and a former participant
in the group. That is a problem that could affect the ability or
willingness of smaller banks to use SOFR, Mr. Wagner said.
The unexpected spike in repo rates in mid-September raised
widespread concern about the use of those rates, which can be
volatile, in the determining how SOFR is calculated.
A group of 10 regional banks in October sent a letter to the
Fed, the Federal Deposit Insurance Corp. and the Office of the
Comptroller of the Currency, arguing that the absence of a
credit-sensitive reference rate could undermine the willingness of
lenders to provide credit in periods of economic uncertainty.
"Obviously, we're studying it, but there are other indices that
you can use," First Republic Chief Financial Officer Mike Roffler
said on the company's earnings call in October. First Republic
began using the Treasury one-year constant maturity rate in recent
months. It "behaves in a much more logical fashion," which is good
for consumers, Mr. Roffler said.
It is possible for borrowers accustomed to Libor to use
derivatives and other financial contracts to arrive at a rate that
resembles the expiring benchmark, analysts said. It could be
difficult, however, for regional banks to sell such strategies to
their customers who are less used to the additional trades that
would be part of such a strategy, they said.
Some regional banks are going to explore alternatives to SOFR,
including the prime rate, which is the base rate banks charge
creditworthy commercial customers, or the effective federal-funds
rate, which reflects the rate large banks charge each other for
loans.
The reluctance of these banks to use SOFR could also help rival
benchmark rates gain traction. The American Financial Exchange,
which allows smaller banks to lend to each other through mutual
lines of credit, also publishes the Ameribor reference rate. It
plans to ask the committee to include both SOFR and Ameribor when
it recommends alterations to contractual language aimed at
minimizing potential problems from the transition, according to
Chief Executive Officer Richard Sandor.
While borrowers can adopt their own contractual language,
participants on the Fed's committee are unlikely to change their
recommended legal templates. Some committee members think banks
will eventually have a choice of different reference rates after
Libor expires, but they said the complexity of the transition
doesn't leave enough time and resources to concurrent preparations
for multiple benchmarks.
"By no means are we discouraging anyone" from offering
alternatives that could address banks' concerns about credit risk,
said Tom Wipf, vice chairman of institutional securities at Morgan
Stanley and chairman of the alternative-rates committee.
"Unfortunately, the task is not that simple, and if it was we
would've done it a long time ago."
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Write to Daniel Kruger at Daniel.Kruger@wsj.com and Allison
Prang at allison.prang@wsj.com
(END) Dow Jones Newswires
December 04, 2019 08:14 ET (13:14 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.
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