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LIBOR

The term LIBOR (which stands for the London Interbank Offered Rate) may not be a mainstream acronym.  However, if you have ever borrowed money for an investment collateral line or for consumer debt such as for a student loan, LIBOR may have affected your borrowing rate.

LIBOR has been the primary benchmark for interest rates utilized by the loan market for the past several decades.  Many loans have used the LIBOR rate as a foundation for establishing the borrowing rate for trillions of dollars of debt (according to Virtus Investment Partners).  In 2017, the Alternative Reference Rates Committee (a committee established by the Federal Reserve, the U.S. central bank) announced that LIBOR would be replaced by the SOFR (the Secured Overnight Financing Rate) at the end of 2021.  The key reasoning behind the switch was to enhance the regulation of the interest rate.  By the end of 2023, all aspects of the LIBOR (across a multitude of time ranges the rate covers) will be eliminated meaning that LIBOR will no longer be as representative in loan documents.  Also, there are alternative reference rates being considered in addition to the SOFR.

From the market’s perspective, change can catalyze uncertainty and given the magnitude of the LIBOR to SOFR switch, there can be volatility in the loan markets as the transition progresses.  The two rates are structurally different (for example, LIBOR is an unsecured rate while SOFR is a secured rate and LIBOR has various term structures while SOFR currently does not) which can create dispersion between the pricing of the LIBOR and SOFR.

While the transition has been well communicated for a number of years and seemingly there are sufficient resources for the transition to be successful, it is a material “changing in the guard” of how various loans are priced and we remain watchful of the shift away from LIBOR.

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Chase D. Conti, CFP®, CAIA

Senior Investment Analyst

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