LIBOR Transition – What Happens to Your Hedge by June 2023?
If you have outstanding LIBOR based hedges, you might have started receiving reminders from your hedge providers prompting some sort of action. LIBOR will be officially discontinued on 6/30/2023, so any LIBOR based hedges with maturities beyond that date will need to be addressed. Here are the potential scenarios for what will happen to the hedges:
Convert Early to Another Index
This is what most lenders are doing. The loan is modified to another index prior to cessation and the cap is modified to align.
- Typically, the new index on the loan is overnight SOFR, compound SOFR, or Term SOFR and we modify the hedge to match.
- Most of the hedge modifications are done at no cost, or in some cases, borrowers even receive payments from the bank because of the value difference between hedges on LIBOR and SOFR.
Do Nothing and Rely on the ISDA Fallback
ISDA (which governs derivative contracts) modified the 2006 Definitions a couple years ago to include robust fallback language in preparation for the discontinuation of LIBOR.
- LIBOR hedges that were executed on or after 1/25/2021 will automatically transition to (compounded SOFR in arrears + 0.11448%) if they aren't modified to another index prior to 6/30/2023.
- LIBOR hedges that were executed before 1/25/2021 do not include this fallback language by default and borrower will need to adhere to the 2020 IBOR Fallback Protocol for the language to apply. Here’s the link to our resource which includes more about the 2020 IBOR Fallback Protocol and Supplement.
If the hedge is a cap associated with a Freddie or Fannie loan, no action should be required by the borrower. The hedge providers will work in coordination with the respective Agency to determine the replacement index. It’s currently expected that Agency LIBOR caps will transition to (compounded SOFR in advance + 0.11448%) effective 7/1/2023.
If your hedge was lender required, then you should speak with your lender before making any modifications.
If you have any questions or would like to discuss how we can help make the transition easier for you, please give us a shout.