Interagency Statement Regarding LIBOR
The NAFCU compliance team has blogged about the London Interbank Offered Rate (LIBOR) several times over the past couple of years. That is because of the imminent end of publishing of the LIBOR benchmarks. There was a blog in January 2020 about the National Credit Union Administration’s (NCUA) 2020 supervisory priorities that discussed LIBOR exposure. There was a subsequent blog in June 2020 that focused on resources on the LIBOR transition issued by the Consumer Financial Protection Bureau (CFPB), including a set of frequently asked questions and a proposed rule to amend Regulation Z to address issues that might arise when credit unions have to replace LIBOR with another index in their credit agreements. There was another blog in March of this year addressing issues under Regulation Z specific to changing indices for home equity lines of credit (HELOCs). And the most recent blog to examine LIBOR was this past June when we looked at the CFPB’s spring 2021 rulemaking agenda and its update on when to expect the CFPB to finalize the proposed rule mentioned above.
Last week, NCUA, CFPB, the federal banking agencies, and state regulators issued a joint statement about their expectations for how credit unions and other financial institutions should manage the risk associated with the shift away from LIBOR. The joint statement noted that the federal banking agencies had issued earlier guidance “encourag[ing] supervised institutions to cease entering into new contracts that use USD LIBOR as a reference rate as soon as practicable, but no later than December 31, 2021.” The joint statement also noted that (1) NCUA provided substantially similar guidance to credit unions, and (2) the NCUA’s guidance recommended that credit unions “ensure existing contracts have robust fallback language that includes a clearly defined alternative reference rate.”
The joint statement examined four separate issues. First, it clarified what the regulators meant by the phrase new LIBOR contracts: “a new contract would include an agreement that (i) creates additional LIBOR exposure for a supervised institution or (ii) extends the term of an existing LIBOR contract.” The statement identified a draw against an existing credit agreement as something that is not a new LIBOR contract. Moreover, the statement expressed the regulators’ expectations that contacts entered into before January 1, 2022, should either not use LIBOR or have fallback language incorporating “a strong and clearly defined alternative reference rate after LIBOR's discontinuation.”
Second, the joint statement identified the regulators’ expectations for due diligence when it comes to selecting a new reference rate to replace LIBOR. It is not enough to just pick a new rate at random. The regulators admonished credit unions and other financial institutions to engage in due diligence to determine that the selected rate is appropriate and tailored to an institution’s specific needs (e.g., products, risk profile, etc.). The statement explained that “supervised institutions should understand how their chosen reference rate is constructed and be aware of any fragilities associated with that rate and the markets that underlie it.”
Third, the statement examined the regulators’ expectations for fallback provisions. The regulators expected that credit unions and other institutions identify which of their agreements use LIBOR and which of those agreements fail to include sufficient fallback clauses. The regulators advised credit unions and financial institutions “to include fallback language in new or updated contracts that provides for using a strong and clearly defined fallback rate when the initial reference rate is discontinued.” If something like the LIBOR transition happens again with another reference rate, then the agreement will already have a back-up plan.
Lastly, the statement makes two final recommendations. The regulators encouraged credit unions and other financial institutions to be transparent and have plans to communicate whatever changes will be required to move away from LIBOR to those who need to know (e.g., members, counterparties, etc.). The regulators recommended that credit unions and other financial institutions understand whether their systems will be operationally ready for the change from LIBOR to a new rate when LIBOR ends.
If your credit union wants to assess its readiness for any move away from LIBOR, the credit union may want to take a look at the self-assessment tool made available by the Office of the Comptroller of the Currency (OCC). The OCC notes that not every part of the tool may be applicable to a bank or credit union depending on an institution’s complexity and risk exposure to LIBOR. That said, whatever parts of the tool that may be relevant may help a credit union understand the risks posed by the end of LIBOR and identify how to alleviate that risk. Credit unions can also look to NCUA supervisory letter number 21-01 for more information about what NCUA will look for with respect to a credit union’s LIBOR transition plan.