By Nema Daghbandan, Esq.
Geraci LLP

As many of you are aware, LIBOR (the London Interbank Offered Rate) was phased out on June 30, 2023. Congress passed the “Adjustable Interest Rate (LIBOR) Act” in March 2022, and the Federal Reserve followed with a regulation in December 2022 that required the transition away from LIBOR and, in most cases, forced the transition to the Fed’s chosen index replacement.

The following guidance is meant for existing loans.

Lenders should use extreme caution if deciding to use LIBOR for new loans.

What Do Your Loan Documents Say?

First, check the language in your loan agreements that describe the interest rate index (“Index”) for your adjustable rate loans. If your loan agreement uses LIBOR as an interest rate index, look to see if the loan agreement:

  • Identifies an Index that will replace LIBOR when it is no longer available, and
  • Gives the lender or another person the right to choose a replacement Index.

OPTION 1

If your loan agreement identifies a replacement Index, you must use that Index.

OPTION 2

If your loan agreement does NOT identify a replacement index, the following applies:

a.) If the lender or another person is authorized to select a new Index to replace LIBOR, that person:

  • May choose to use the Federal Reserve’s Index replacement; or
  • May instead choose to use an alternative Index replacement that is commercially reasonable under terms of your loan agreement.

b.) If no person is authorized to select a new Index to replace LIBOR, you must use the Federal Reserve’s replacement Index (which are different forms of SOFR [Secured Overnight Financing Rate] described in the table below). Please note that while the federal law and regulation do not require notification to the borrower, your loan documents may require borrower notification.

PLEASE NOTE: Federal law says that when you use the Federal Reserve’s Index (“Fed’s Index”) to replace LIBOR:

  1. The Fed’s Index is commercially reasonable;
  2. Your borrowers may not bring any claim against you for using the Fed’s Index; and
  3. You may use the Fed’s Index without first getting your borrowers’ consent.

Choosing another Index that is not the Fed’s Index will not provide you with these safe harbor provisions and will likely require your borrowers’ consent.

Replacement Index and Margin Adjustment

The Federal Reserve’s regulation has a list of both:

  • Indexes to replace LIBOR (which are different forms of SOFR), and
  • Adjustments that you need to make to your current margin, which makes up for the average difference between LIBOR and SOFR.

The Federal Reserve’s replacement Indexes and margin adjustments are as follows:

As you know, the interest rate for a LIBOR loan is calculated by adding a “margin” to LIBOR. For example, if LIBOR is 4% and the margin is 1.5%, the interest rate for the applicable period will be 5.5%. Apply the Margin Adjustment by adding the amount to the margin. Continuing the example, assume you were previously using 1 month LIBOR, then instead of the margin being 1.5% the margin will now be 1.61448%. You are permitted to continue using any rounding methodology found in your loan agreement.

Please Note: All of the above guidance is limited to non-consumer loans that are neither derivative transactions nor loans made by banks or Federal Housing Finance Agency regulated entities.