Credit Unions May Face Risks Amid LIBOR Transition Next Year

12/8/2020

While other events have captured national and global attention in recent months, the transition away from the London Interbank Offered Rate (LIBOR) that began in 2017 continues to move forward. LIBOR’s expected demise is at the end of 2021, and credit unions should begin preparing for the transition now.

Strategic Link partner, Catalyst Corporate Federal Credit Union, can help. Its Brokerage Team stands ready to offer credits unions guidance through the process.

For decades, LIBOR rates have been used globally as reference rates for financial products. U.S. dollar-denominated LIBOR rates have been used as a nationwide benchmark for everything from home mortgages to interest rate swaps. By one estimate, as many as half of the existing contracts using LIBOR will expire after 2021.

In the United States, LIBOR’s “heir apparent” is the Secured Overnight Financing Rate (SOFR). Regardless of the chosen benchmark, transitioning from LIBOR has its risks. In July, the Federal Financial Institutions Examination Council — of which the NCUA is a member — released its Joint Statement on Managing the LIBOR Transition. The statement enumerates the types of risk examiners will focus on but does not endorse a specific replacement benchmark.

FFIEC’s statement lists many potential risks. The first is an institution’s ability to correctly identify its exposure to LIBOR. Credit unions that use LIBOR as a loan benchmark face consumer protection, litigation, and reputational risks related to transitioning existing loans that mature after 2021. While floating rate loan contracts typically contain “fallback” language regarding the replacement of a loan’s benchmark, they are often written with only a temporary replacement in mind. When selecting a permanent replacement benchmark, credit unions can take care to ensure members are treated fairly. 

It’s important to note that credit unions that do not use LIBOR as a benchmark for floating rate loans may still be exposed — they may have exposure through investments or third-party service providers.

While SOFR has some advantages as a LIBOR replacement, it also has shortcomings as a benchmark for loans. LIBOR rates have an inherent element of credit risk that SOFR does not. SOFR transactions use U.S. Treasuries as collateral, and are, therefore, considered risk free. The Federal Reserve Bank of New York has convened the Credit Sensitivity Group to address this concern and attempt to find an acceptable, credit-sensitive option to replace LIBOR.

As the transition from LIBOR nears, credit union preparation remains essential. Furthermore, the FFIEC statement directly notes that, “While some smaller and less complex institutions may hold little to no LIBOR-denominated assets and liabilities, the change will affect almost every institution.” So, all credit unions should expect their NCUA exams to address the LIBOR transition to some extent.

For more timely economic insights, register to attend Catalyst Corporate’s “2021 Insights & Outlooks” online presentation on Dec. 17. For more background on LIBOR, SOFR, and the need to transition, check out the Strategic Link partner’s helpful blog: From LIBOR to SOFR: 7 Things You Need to Know.”

Learn more about the services Catalyst Corporate offers by visiting its virtual booth at the Strategic Link Trade Show. Chat directly with the team in their booth on Dec. 9, from 11 a.m. to 1 p.m. PST. Additionally, Additionally, from Dec. 1 to Dec. 14, you can earn points as you explore the Exhibition Hall for a chance to win a cash prize! A random winner will be chosen Dec. 15, so visit the trade show floor today!

Posted in Industry Insight, Strategic Link.