The recent disruption in the banking market should cause any organization to evaluate its concentration of capital, diversify banking relationships, forecast cash flow, and develop business response plans to mitigate risk.
As you reach out to your advisors to discuss these strategies, it is an ideal time to consider and prepare for another area of impending risk: the end of LIBOR (London Interbank Offered Rate).
ASU 2022-04 extended the mandatory date of transition from LIBOR to a successor rate from December 31, 2022 to December 31, 2024 (under Topic 848). At that time, entities will need to account for contract modifications that result from the discontinuation of LIBOR for affected leases, debt agreements and other variable-rate contracts.
Why is this change being made?
LIBOR is determined based on the rate banks state they would charge each other for overnight borrowings and is widely used in debt and lease agreements, interest rate swaps, and similar contracts that reference a variable interest rate. However, rising concern over the ability for banks to manipulate the LIBOR rate has led the market to transition to the Secured Overnight Financing Rate (SOFR), as SOFR is based on observable rates actually charged, rather than a stated rate.
What do I need to do to prepare?
Organizations must evaluate their variable-rate agreements to determine whether the agreements contemplate a change in the reference rate, and if so, whether the new rate will be SOFR or some other rate. Depending on the terms of particular agreements, the transition may affect both cash flows and accounting results.
What is My Successor Rate?
To determine which rate will replace LIBOR, you must first establish if the contract stipulates a successor rate. If it does not, it is imperative to proactively contact your lender to inquire about the successor rate and how you can plan to account for the contract modification.
Lenders are highly motivated to move away from LIBOR, so now is the time to assess if any of your contracts are LIBOR-based and begin to pursue an alternative rate. In time, your options could become more limited by legislative mandate or the possibility of getting locked in at the last LIBOR rate or at the bank’s full borrowing costs.