LIBOR and the Future of Floating Rate Mortgage Loans
In their Financing column, Jeffrey B. Steiner and Jason R. Goldstein discuss the implications for real estate lenders in the wake of the anticipated phase-out of the much-used LIBOR index rate.
September 21, 2017 at 12:00 AM
12 minute read
In light of the fact that many real estate lenders rely upon the London Interbank Offered Rate (LIBOR) as a principal index rate, there has been a great deal of concern throughout the industry about the anticipated phase-out of the much-used index, currently anticipated to occur at the end of 2021. As real estate financiers debate whether they may benefit from LIBOR's replacement in the long-term and what existing or newly-minted index rate may ultimately replace LIBOR, lawyers working in the field should concentrate on ensuring that loan documents are drafted to preserve the benefit of lenders' bargains even in the absence of the key index rate used to determine the loan's all-in interest rate.
Contemplating a Substitution
Interest rates for floating rate loans based on the LIBOR index are typically priced on the basis of a 30-day LIBOR contract plus some negotiated “spread” over such index rate; the sum represents the loan's “all-in” rate. In light of past events whereby specifically identified index rates unexpectedly became obsolete, many drafters of real estate finance documents regularly contemplate a substitution of the LIBOR index with an alternative “base rate” or “prime rate” should LIBOR cease to be a viable means for determining a loan's interest rate. For instance, in the following loan document provision, a LIBOR loan is allowed to convert to an alternative “base rate” when LIBOR can no longer be ascertained:
In the event that lender shall have determined that by reason of circumstances affecting the interbank Eurodollar market, adequate and reasonable means do not exist for ascertaining LIBOR, then lender shall forthwith give notice of such determination to borrower. If such notice is given, the related outstanding LIBOR-based loan shall be converted, on the [effective date identified in such notice], to a Base Rate-based loan.
The related loan documents would provide that the “base rate” may be a “prime rate” published in a leading financial periodical (for example, the Wall Street Journal) or some other index that the lender determines would be a reasonable substitute for LIBOR. Provisions for an alternative index to calculate interest are essential at all times but especially in light of the current expectations concerning the availability of LIBOR.
Courts Weigh In on Rates
If the index used to calculate interest for a particular loan should no longer exist, and the applicable loan documents do not provide for lender's selection of an alternative index, a borrower may object to the replacement index proposed by the lender or even argue that the interest rate be limited to the applicable interest rate spread due under the loan. In these cases, the parties may need to resolve their disputes in court.
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