On October 23, 2020, the International Swaps and Derivatives Association (ISDA) published the much anticipated IBOR Fallback Protocol (Protocol). Firms that sign up for the Protocol agree to the spread adjustment and the fallback rates if LIBOR becomes unavailable in the future. Most community banks have some loans or deposits tied to LIBOR, and many community banks have used LIBOR hedges to help borrowers manage interest rate risk.
Tag: Interest Rates
In the next twelve months, the transition from LIBOR to alternative Risk-free Rates (SOFR in the US) will take an important course. Banks with products tied to LIBOR need to understand the implications of ISDA Fallback Protocol and how to manage possible risks with this critical industry transition. Shortly, ISDA (International Swaps and Derivatives Association) will be publishing LIBOR Fallback Protocol. Firms that sign up for the LIBOR Fallback Protocol agree to the spread adjustment and the fallback rates if LIBOR becomes unavailable in the future.
Last Friday’s economic data indicated that U.S. nonfarm payrolls rose by 2.5 million in May, compared with expectations for a decline of 7.5 million. In April, nonfarm payroll fell by 20.7 million in the largest single-month drop in records dating back to 1939. Throughout last week, interest rates rose (the ten-year yield rising by 25bps) and the yield curve steepened relentlessly - spread between five-year notes and 30-year bonds widened on Friday to 120 basis points, a level last seen in December 2016.
Some pundits and economists are sounding alarms that by increasing interest rates too fast or too high, the Federal Reserve might cause the next recession. However, we believe that bankers should direct their concerns to other economic and credit developments – such as low cap rates, high LTVs, and dubious pro forma cash flows. We believe that the likelihood of a Federal Reserve policy error causing the next recession is exceedingly low, and the cause and effect between short-term interest rates and recessions is not so obvious.
Bankers are bombarded with views, opinions and predictions. Now that the FOMC raised interest rates by 25 basis points and has embarked on a tightening cycle, most economists, pundits and correspondent salespeople are trying to convince community bankers of their specific rate view. But bankers should be circumspect of others’ rate views and should not buy into one rate path but instead consider various possible interest rate paths. Bankers should be mindful of the dispersion around that mean.