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Yep, It's Time to Talk LIBOR ... Again

The transition off LIBOR at the the end of 2021 may seem like old news, but there are many issues banks needs to address, and time is running short. Dallas Wells and Jim Young talk about the items still on the lengthy LIBOR to-do list for banks this year. 


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Jim Young:
Hi and welcome to The Purposeful Banker, the podcast brought to you by PrecisionLender, where we discuss the big topics on the minds of today's best bankers. I'm your host, Jim Young, Director of Content at PrecisionLender and joined again by Dallas Wells, our EVP of Strategy. There's a famous press conference rant by Allen Iverson from back in the day that went viral even before social media was around to make things go viral. And in it, Allen Iverson, who is an NBA star famous for going all out in games, but then treating practice as sort of an effort optional time period, he got tired of being asked about his practice habits.
And so he goes on this rant in this press conference, and I'll have a link to it, a YouTube link to it, where he just keeps repeating, "We're talking about practice," with this incredulous tone, as if he can't believe we're still on this topic. And I bring this up because, and I'm not going to try to imitate Iverson's voice here, but Dallas, we're talking about LIBOR. LIBOR, Dallas! Anyways, welcome to the show.
Dallas Wells: Thanks for that warm welcome.
Jim Young: Well, I'll just start right there. This is a little bit of a running joke here in which I have professed that I'm over-talking about LIBOR. And then Dallas comes up with usually legitimate reasons for talking about LIBOR. So I'll start right there. Why are we talking about LIBOR again on this podcast?
Dallas Wells: Unfortunately just, I don't know, a necessary evil at this point. I get why this is not a super exciting topic for Jim or maybe for any folks listening. It doesn't seem like it's going to be something that interesting, but it's really critical. We're talking about it because the regulators are talking about it. So the things that your primary regulator and friendly, on-site examiners care deeply about, you should also care deeply about.
In addition to Jim's much more interesting YouTube link to Allen Iverson, we'll also include a link to an article from early in March, in American Banker, that talks about some of the regulatory pressure starting to come from the Fed, in particular, that banks need to be ready for this and that as they are not ready, as we get closer to some of these deadlines, it's going to be considered a safety and soundness issue.
This is not going to be just like a, hey, you really ought to get around to this. This is a big deal that will impact CAMELS ratings and all sorts of follow on issues. It matters. And banks need to be paying attention to this and they need to be doing some serious work to be ready in time.
Jim Young: Okay. All right. Also, I should note that in looking up my Allen Iverson clip, I came across a clip from the show, the Apple TV show, Ted Lasso, in which he goes the opposite direction on practice and goes on a rant about the importance of it. I'll put that clip up there too, just to be fair and balanced. But Dallas, couldn't bankers be a little forgiven if, I know you said it's critical, but if they roll their eyes a little bit at this LIBOR deadline? I mean, it feels like we've been told, "Oh, you definitely got to have this stuff done into 2021." But then you see those dates out there for mid 2023 for when we're really going to retire some of this stuff. I guess I'm wondering if that may be contributing to a little bit of the, not the lack of seriousness, but maybe lack of panic.
Dallas Wells: I think there's two things there. So number one, exactly as you've mentioned, there is some confusion about the dates and some of those dates have moved. Those mid 2023 dates, those are a fairly recent change. The most common LIBOR settings, so three-month and six-month, in particular, one-month and three-months, excuse me, the most common ones. Those will continue to be published until June of 2023.
I think a lot of bankers saw that headline and were like, "Oh, here's the relief we've been waiting for." So even just subconsciously, of all the things to deal with each day, this one gets pushed lower on the list. It doesn't feel that urgent. What did not change is the end-of-year deadline. You cannot make new loans tied to LIBOR after December 31st. That date hasn't changed.
They extended the publishing times on some of those settings, but that was only because some of those existing deals, loans, derivatives, everything else that's tied to LIBOR that are still out there, it gives them a little extra time to wind down. Because some of those are just really difficult to add fallback language or renegotiate or change. They just are stuck where they are. It's best to just give them enough time with settings of LIBOR to be able to expire or mature. So that's all that is. It's time for that existing stuff. All the changes for booking new deals still have to be done by the end of the year. So that's part of it, is date confusion.
I think the other thing is bankers have become a little bit accustomed to some of these dates being moved from their regulators and especially through the pandemic. So we saw dates be moved on CECL, gosh, multiple times. Even going back to mark-to-market accounting, those rules got moved a bunch of times. It's fairly standard for big industry changes like this, for the regulators to blink a little bit as we get close. I think especially given the pandemic this year, I mean, heck the IRS has extended tax deadlines. If even the IRS is willing to give you an extra 30 days, surely we'll be getting some extra time to make a big adjustment like this.
But the Fed, the Alternative Rate Committee, and central banks around the world have all said, "There's too many players involved. There's too many regulatory entities. It's not that easy to move. So the date still stands." So they've not moved.
I think there's still some banks that probably still expect them to blink on this and to actually change that deadline. Maybe that happens, but we're close enough now that I sure as heck wouldn't count on it.
Jim Young: All right. Okay. I will take your word for it. This is not a drill. This is serious, this time. But you mentioned the magic word from the last 12 months, which is pandemic. If I'm a banker and you tell me, "Whoa, buddy, it's time to really start taking LIBOR seriously," I might say to you, "I'm not sure if you're aware, but we had PPP. We got rates close to zero." Just last week, last podcast, you and I were talking about banks that are trying to now turn away deposits. You know what I mean? These are not ordinary times. There's a lot of stuff going on. So can't LIBOR just take a number at this point?
Dallas Wells: It effectively has, because there are so many massive issues to deal with around next rounds of PPP and stimulus payments to be dealt with. Heck, even the extension of the tax deadlines, that changes things around, quarterly tax payments that banks often help collect and all sorts of stuff. Things have been moving all over the place for banks' customers, whether that be consumers or businesses. There's been all sorts of programs to facilitate and build systems for, learn new rules on, and those have all been very urgent and time sensitive and on what felt like every time, impossible deadlines. That doesn't leave a lot of hours left in the day for LIBOR, so I fully get that.
But I think that's why the regulators are starting to use stronger language than they typically use for this kind of stuff and saying, "Hey, we're not kidding. This is a safety and soundness issue. Get on it. And spend money on it if you need to." So LIBOR has taken a number, but we're up to the point now where there's enough yet to be done that it needs to move up that list of urgency and be on par with things like the next round of PPP or whatever thing comes next.
Jim Young: All right. Okay. I'm done being combative on this. You have beaten me into submission on this and I will stop questioning the importance of this topic.
Dallas Wells: I doubt that, but okay.
Jim Young: Alright ... but you mentioned a little bit of this and you've had conversations, a lot of conversations, with bankers recently. I'm curious about your sense, when you take the temperature of the water, about how seriously/not seriously they're taking this. I know you're talking about some bankers expecting the Fed to blink and that sort of stuff, but in your conversations about, hey, what's on your radar, what's on your to-do list, what's your sense about where this ranks?
Dallas Wells: It's suddenly growing, which is why I thought it would be relevant to talk about. It's been on our radar for a while. We keep bringing it up with our clients. A lot of them are just, they're like, "Yeah, I think somebody is working on that. We'll get to it and we'll let you know." But it was, clearly, it was not that big of a deal to them. And that's changed. Really, over the last month, we've started having a lot more conversations go the other direction, where the bankers are asking us about it. And there, all of a sudden, there's been teams internally working on it, but a lot of that was very specific systems-related things and redoing loan language. The early thing to do was to, hey, if you have loans that are tied to LIBOR and go beyond that date where the index is no longer published, we got to have some fallback language put in there, into those loan agreements.
So there was some stuff to be done that was high priority. There was groups working on it, but then it just got set aside like, and the rest of it we'll get to later. Well, I think later is now arriving and we're hearing more and more about it.
That said, just earlier today we had a group of bankers together talking about some current issues, 20-25 bankers from some of the biggest banks in North America. We put, I don't know, four or five options on the screen as part of a poll and said, "Which of these is most important?" And the very bottom of that list was the LIBOR transition. And so, it had, I guess, if I do the math right, I think two of those 20 something bankers said that that was most important. Everybody else had other issues ahead of it, profitability issues and credit risk things that they're struggling through right now.
That's a long way of saying I don't think, it's still not the top priority for a lot of banks. But it seems to be quickly moving up the list. The project teams seem to be growing at banks where they're realizing how far reaching this is and how many things it touches and how many processes, how many people. So the project teams have gotten big accordingly and the list of work to be done has also gotten pretty long.
Jim Young: Well, let's talk about that actually, because that was something that was interesting. I think it's easy to look at LIBOR, and this is probably again, why I gently mock it and think of it as a back-of-the-bank, bean-counter-math-calculation thing that you got to do. But you were talking and I'm wondering if you can elaborate on the customer problems and client-facing issues or challenges that come with this.
Dallas Wells: So full disclosure, that was my first reaction, too. One of our clients in particular has been working on this for over a year, at this point, year and a half maybe, where every time we try to set meetings or have conversations, "I can't, I'm working on LIBOR stuff." And we're like, "What is he doing?"
Jim Young: To the point where you probably thought it was just an excuse, right? 
Dallas Wells: Yeah, and clearly, he's blowing me off for other reasons. But I thought the same thing, because they kept asking, "Well, what's PrecisionLender going to do about LIBOR?" And it was like, "Well, we're going to, you want to use SOFR instead? Okay, we point, click, save, done." It's an easy change. As we dug into it a little more, we understood why this was such a big issue. It does start as a back office thing. I promise we won't get into the interest calculation methodology here, primarily because I'm the wrong person to do that. But SOFR interest accruals are going to be calculated and handled differently than they are for LIBOR. LIBOR is a in-advance index. You can know up front what the interest payment on a deal is going to be.
SOFR is calculated in arrears, so looking backwards. If you have quarterly payments, you'll get to the end of a quarter and they will tally up what daily SOFR was for all those days. Then they'll tell you the day before it's due, what your interest payment is. Bank systems are not set up that way. How you compound those rates is also a little wonky. Do you use daily SOFR? Do you use a trailing 30-day average? Do you use a 90-day average to smooth out any noise in there? The back office stuff got more complicated than people expected really quickly, especially because a lot of the systems doing things like interest calculations are coded in COBOL and they're 40 years old. So changes are hard and painful. And those changes were being handled by this team of specialists at the bank and it felt like a back office thing.
Everybody had to wait on them to figure out what was even possible in the bank systems.
Before we could make changes to, okay, here's what our new loan agreements will have to say. When we actually reference how those interest calculations are made, we have to put it in the loan agreement, but we got to wait on the systems updates before we know exactly what that is. And those are taking long enough that everybody's still in wait and see, but now it's becoming a little more critical. Those systems issues have become all consuming. And that's really the only part of this that anyone's considering. I think, my two cents, I think that's causing banks to miss a much bigger issue. So that's the other part of this that we should probably talk about, which is that there are customer implications to this.
One of the derivatives partners that we work with has been obviously following along very closely with this, because their whole world revolves around LIBORs and LIBOR swap curve. There hasn't been a lot of volume yet in any of the SOFR stuff. Nobody's doing SOFR-based deals yet. They started asking some of their customers, "Hey, we know you got your system set up and ready and we're going to do some test deals. Where are they, so that we can also do some test deals?" And the response was, "The customers don't want it. They don't like SOFR. They've never heard of it. It's calculated weird. We had to go through this big disclosure. So they just wanted to do another deal based on LIBOR. We're not to the deadline yet. So we said, 'Sure.' Why would we rock the boat?" So nobody's doing SOFR, because nobody else is doing SOFR. It's this who-blinks-first kind of thing.
What that tells me, is that there's probably some bigger customer education and discussion to be ready for than maybe you expect. Also, for deals that are typically priced in LIBOR, you're often talking middle market-type deals and larger C&I-type credits. You've got some experienced bankers there that have really shaped their view of the market and of deals around LIBOR. They have this gut feel again, informed by lots of experience and war stories, of this is a LIBOR plus 180 deal. I might be able to stretch it to 190, but if it's LIBOR or plus two anything, I'm going to lose it and I'm going to lose it to one of these three banks. They have this feel. And the base currency there, the base factor, that all that is based around is LIBOR plus the spreads. And it's not as simple as just, well, what's the difference between LIBOR and SOFR and the spreads will correlate. I don't think it's going to be that straightforward.
So your bankers have to be retrained. Your customers have to be retrained. And then you've got systems that are now trying to look at some things that are forward looking, some things that are backwards looking. And banks that were just using LIBOR might start using four or five different indices in place of those. So you've got to have your bankers choose the right index for the right type of deal for the right type of customer and tie it to the right funding curve, select the right thing in the systems, give it the right thing in the loan documents. That's where I say, it's starting to spiderweb into all these things that maybe you didn't fully expect. It goes beyond systems and starts being a human, training, understanding and behavior change problem.
And those take time. And those take effort. And those take repeating things and creating content around and messaging around. And not many banks are working on that yet. So that's the part that I think is going to be a mad scramble, is figuring out how to get those things done and actually get customers from LIBOR to SOFR for new deals and for some of their existing ones that you feel like you have some exposure on. That's all stuff that's yet to be done at just about every bank we talk to.
Jim Young: Yikes. It's interesting. You talked about the field part of it. And I started thinking, as usual, of what sports analogy would work on this. I would imagine it would be like being a caddy at a club where they suddenly they start measuring all the holes in the metric system. And you're like, "Well, I think a five iron will work here, but I don't exactly know how far that distance is." Like the gut feel stuff that at least starts you out and helps your decision making narrow down and say, "Well, it's going to be this or this, but it's going to be this ballpark." If that goes out the window, I can see how that would complicate things quite a bit.
Dallas Wells: To maybe overdo the analogy, what banks have done is put the new distance on the tee box. But that's it. Nothing else has been changed or adjusted. They haven't trained the caddies on that. None of the players are going to know to expect that when they show up. A lot of this is sitting with the systems folks and with treasury groups that are trying to figure out, well, what's this mean for funds transfer pricing? All those curves and internal funding costs and funding credits, all that stuff's built on LIBOR. So we've got to build new curves for that. They're worried about the finance nerd part of this, where they're trying to build forward looking curves off of SOFR, which doesn't really exist yet. But there's some theories out there about what might be the right way to do that. They're trying to piece together that stuff.
Then they're like, "Well, but this is off one and a half basis points from our old LIBOR curve, so we need to find a way to adjust that." And I promise you, the basis point and a half that you're worried about being off in the calculation, will end up being noise in the human messiness, once this actually has to be booked out in the field. Where spreads get changed because well, they're usually LIBOR plus 200. So I have to do SOFR plus 200 just so that it doesn't confuse them or frighten them or they don't get upset because it's not the same deal they got before. That will cause a lot bigger changes in spreads and profitability and stuff than worrying about the nuance of the liquidity premium that you add between months six and eight.
At some point banks have to move on from that stuff as best as we can and get to those behavior change things that are going to be potentially really messy if banks don't get their arms around those starting now. Because your cut-over date is going to realistically have to be before the end of the year. Again, just looking at it pragmatically, it's holiday time. It's end of year. You're trying to hit end-of-year numbers. People are gone for Thanksgiving and family holidays. Kids are out of school, so so-and-so can't make the meeting. Those are the things that are happening at the end of the year. These cut-over dates have to happen November or earlier. And nobody's ready. That's why we're talking about something that Jim's not too excited about.
Jim Young: And my last question I had on this was can you offer me assurances that this is going to be the last LIBOR podcast we're going to do? But basically, congratulations, you have convinced me that we'll almost certainly be doing another LIBOR podcast sometime come fall.
Dallas Wells: Don't be surprised if we have a substitute host at some point, I guess, because we are going to have to talk about this again later, at least as a status check of like, hey, are we doing okay? So we'll check in down the road, but only because I think it is going to become a bigger part of the conversation. I think we'll have to. We'll have to pay attention to it.
Jim Young: All right. Okay. Well, that'll do it for this week's show, but obviously again, it won't do it for all of our LIBOR talk. But Dallas, and nonetheless, thanks for coming on.
Dallas Wells: Again, I'm not feeling that you're actually super thankful, but you're welcome. And thanks for having me.
Jim Young: All right. Thanks so much for listening. And now for a few friendly reminders. If you want to listen to more podcasts, check out more of our content, you can visit the resource page at or head over to our homepage to learn more about the company behind the content. If you like what you've been hearing, please make sure to subscribe to the feed in Apple Podcasts, Google Play or Stitcher. We'd love to get ratings and feedback on any of those platforms. Until next time, this is Jim Young, Dallas Wells. You've been listening to Purposeful Banker.