Federal Government Addresses LIBOR Transition
In the recently-enacted 2022 federal spending bill, Congress included the Adjustable Interest Rate (LIBOR) Act (the Act), which addresses the expected turmoil that will result from the transition from LIBOR to SOFR as a benchmark rate for adjustable-rate loan products. Importantly, the Act effectively provides a fallback provision for those existing adjustable rate contracts that had inadequate (or no) fallback provisions, although the Act is limited to the overnight, and 1-, 3-, 6-, and 12-month tenors of U.S. dollar LIBOR and does not include the 1-week or 2-month tenors of U.S. dollar LIBOR.
On the first London banking day after June 30, 2023 (unless the Federal Reserve Board (FRB) determines that any LIBOR tenor will cease to be published or be representative on a different date) (the LIBOR replacement date), the FRB-selected benchmark replacement (which will be based on SOFR, and will include tenor spread adjustments defined in the Act) will be the official replacement for any consumer credit product that (1) doesn’t contain fallback provisions, or (2) has fallback provisions that fail to identify a specific benchmark replacement or a person designated to select the replacement benchmark (a determining person). The Act nullifies portions of existing fallback provisions that identify benchmark replacements based in any way on LIBOR (except to account for the difference between LIBOR and the benchmark replacement), or that require a person to conduct a poll, survey, or inquiry for quotes or information regarding interbank lending or deposit rates.
If a determining person fails to select a benchmark replacement by the earlier of the LIBOR replacement date or the latest date for selecting a benchmark replacement according to the terms of the LIBOR contract, then the FRB-selected benchmark replacement will automatically apply.
Further, the Act identifies tenor spread adjustments for overnight, 1-, 3-, 6-, and 12-month LIBOR and provides for continuity of contract and safe harbor provisions in relation to this transition. Additionally, the Act addresses how the transition affects income tax treatment under Section 1001 of the Internal Revenue Code of 1986, and the ability of federally-regulated banks to select benchmark indexes that are not based on SOFR for their own purposes, such as funding models.
It is important to note that recent CFPB guidance regarding closed-end adjustable rate mortgage requirements under TILA and Regulation Z indicated that SOFR replacements for LIBOR benchmark rates for 1-, 3-, and 6-month tenors would be comparable to existing LIBOR tenors and therefore would not be deemed refinancings under TILA and Regulation Z. However, this guidance does not expressly address other tenors, such as a 1-year SOFR tenor, although guidance on acceptable considerations for replacement indices is provided. Accordingly, if a lender is deemed not to have sufficiently considered the relevant factors when selecting a replacement index and tenor, that could result in a refinancing under TILA and Regulation Z, thereby requiring actions such as new disclosures and new ability to repay underwriting considerations.
The Act requires the FRB to implement enacting regulations by September 11, 2022.
