Replacing LIBOR• A reissuance is the deemed extinguishment of a debt obligation and the...

Tuesday, May 21, 2019Los Angeles, California

Replacing LIBOR

May 19-22, 2019 • Los Angeles, California113th Annual Conference

Learn more by visiting us at gfoa.org • #GFOA2019

B. Jonas BieryBusiness Services Manager, Bureau of Environmental Services, City of Portland, ORVictor HsuPartner, Norton Rose Fullbright US LLPPatrick J. McCoyDirector of Finance, Metropolitan Transportation Authority, New YorkNat SingerManaging Director, Swap Financial Group

Swap Financial Group

Government Finance Officers Association

May 21, 2019

Replacing LIBOR

Swap Financial Group 3

How We Got Here

2008 Financial CrisisReports of abuse from

LIBOR panel banks

Aftermath1. Manipulation lawsuits

2. Questionable data discovered

Banks desires to relieve duties of being a LIBOR

panel bank

2014Fed creates Alternative

Reference Rates Committee (ARRC)

July 2017UK Financial Conduct

Authority announces deal with banks to 2021

TodayScrambling to prepare for the possible end of LIBOR


Historical Volume of SOFR Based Transactions

Note; Market information as of April 23, 2019.

Introduction to the Secured Overnight Financing Rate (“SOFR”)

■ Secured Overnight Financing Rate (SOFR), is a broad-based US Treasury repo financing index based on actual transactions rather than submissions─ The overnight Treasury repo market is the largest/most active market in any tenor of US rates markets─ SOFR has aggregated nearly $800 billion in daily repo transaction volumes ─ Daily publication of the SOFR began on April 3, 2018

LIBOR versus SOFR Historical Daily Resets

■ [ ]


ARRC Envisions a “Paced Transition” for Implementing the New Successor Rate

Source: Alternative Rates Reference Committee, November 2017.

2018, Q2 2018, Q4 2019, Q1 2020, Q1 2021, Q22021,

Q4

Fed begins to publish SOFR data on a daily basis

Trading begins in futures and/or bilateral, uncleared, swaps that reference SOFR

Trading begins in cleared SOFR swaps

Clearing Houses begin accepting SOFR swaps and SOFR as discounting and collateral interest rate

Clearing Houses only allow new trades with SOFR as discounting and collateral interest rate

End of LIBOR?


Potential Paths After December 31, 2021SFG can identify a few potential outcomes of LIBOR transition through 2021

After December 31,

2021

Book End #1• All banks opt out• LIBOR ceases to be

published• Contractual

fallbacks kick in• Chaos ensues

Book End #2• Banks agree to

extend their commitment to LIBOR

• More time is given to develop the SOFR market (or an alternative market)

• Status quo vs. today

Hybrid Outcome• Some (but not all) panel banks continue

to participate in LIBOR• ICE organization revamps index

calculation methodology and renews commitment

• Regulators deem LIBOR unreliable• New fallbacks kick in, legacy contracts

persist


Implications for LIBOR-Based Swaps and Floating Rate Debt Obligations

Legacy Contracts Tax and Accounting Economic• Engage with

counsel/advisors to understand current fallback language in documents

• Typical language, (a) polling a sample of banks, (b) last reset, or (c) another variable rate index

• Long-dated public FRNs may require 100% bondholder consent to amend

• Tax- Could amendments

cause a “re-issuance” of the tax-exempt debt?

• Accounting- Do swap

conversions trigger “material amendment” and derivative with embedded financing?

• Debt- Refinancing into

SOFR-based products with higher credit spread?

• Swap- Will issuers receive

appropriate compensation (credit spread adjustment to floating leg) for converting from LIBOR to SOFR?


■ Fallback language for new deals (and possibly legacy deals if practical) will be formally proposed by the ARRC in the coming weeks

■ Fallback language will likely include a waterfall approach until a replacement rate can be established:

1. Forward-Looking Term SOFR2. Compounded in Arrears SOFR3. Fed Recommended Rate4. ISDA Recommended Rate5. “Industry Standard”


Debt (Floating Rate Notes / Bank Loans)■ ISDA plans to publish a Protocol that all

counterparties can adopt for new, and legacy, transactions by the end of 2019

■ Based on a 2018 consultation where ISDA requested market participants’ feedback, the fallback will be based on daily compounded SOFR rate, paid in arrears

─ Additionally, the “credit” spread adjustment will be some form of historical average spread between LIBOR and daily compounded SOFR

■ ISDA is expected to conduct a supplemental consultation in the coming weeks to poll market preference for some of the finer details of the credit spread adjustment calculation

Derivatives (ISDA)

■ Triggers = Hopefully will be aligned for pre-cessation and cessation triggers, alike

■ Credit Spread Adjustment = Likely will be tied to ISDA’s calculation process/methodology

Possible Similarities (All Shown Products)

New Fallback Languages will Convert LIBOR to SOFR + a “Credit” Spread


Historical Monthly Resets of 1-month LIBOR vs. Monthly Compounded Overnight UST Repo Rates


Rolling Average Spread between Indices

Will Technical Factors Continue to Push LIBOR/SOFR Credit Spread Lower?

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

Mar-98 Aug-01 Feb-05 Aug-08 Feb-12 Aug-15 Mar-19

Rate

s (%

)

1m LIBOR

Overnight Treasury GC Repo PrimaryDealer Survey RateIndicative SOFR

Official SOFR

Historical Lookback

Average1m LIBOR

Average "SOFR" Spread

20-years 2.06% 1.84% 22 bp10-years 0.55% 0.44% 12 bp5-years 0.87% 0.75% 12 bp3-years 1.32% 1.18% 15 bp2-years 1.72% 1.57% 15 bp1-year 2.19% 2.07% 12 bp

0.5-year 2.39% 2.33% 7 bp


SFG Has Focused on Three Different Alternatives on Restructuring Swaps

SOFR

Fed Funds

SIFMA

• Banks have begun to make markets in long-dated SOFR-based swaps• To our knowledge, no municipalities have participated but it’s likely that

trades are imminent• While the SOFR market is expected to replace most global USD-

LIBOR transactions, participants have been slow to adopt

• Effective Federal Funds Rate Swaps (otherwise known as OIS) have a long trading history though never have been quite as liquid as LIBOR

• Because both EFFR and SOFR are overnight indices, they have been closely aligned with each historically

• EFFR’s established history has been a factor in issuers gravitating to it

• There continues to be liquidity (although more limited than before 2008) in SIFMA-based swap transactions

• Historically, SIFMA has averaged approximately 68% to 70% 1-month LIBOR though the swap market generally prices in a premium

• Converting to SIFMA would increase the fixed rate that an issuer pays


Disclosure of Conflicts of Interest and Legal or Disciplinary EventsPursuant to Municipal Securities Rulemaking Board (“MSRB”) Rule G-42, on Duties of Non-Solicitor Municipal Advisors, Municipal Advisors are required to make certain written disclosures to clients which include, amongst other things, Conflicts of Interest and any Legal or Disciplinary events of Swap Financial Group, LLC and its associated persons.

Conflicts of Interest

Swap Financial Group, LLC represents that in connection with the issuance of municipal securities, Swap Financial Group, LLC may receive compensation from an Issuer or Obligated Person for services rendered, which compensation is contingent upon the successful closing of a transaction and/or is based on the size of a transaction. Consistent with the requirements of MSRB Rule G-42, Swap Financial Group, LLC hereby discloses that such contingent and/or transactional compensation may present a potential conflict of interest regarding Swap Financial Group, LLC’s ability to provide unbiased advice to enter into such transaction. This conflict of interest will not impair Swap Financial Group, LLC’s ability to render unbiased and competent advice or to fulfill its fiduciary duty to the Issuer.

If Swap Financial Group, LLC becomes aware of any additional potential or actual conflict of interest after this disclosure, Swap Financial Group, LLC will disclose the detailed information in writing to the Issuer in a timely manner.

Legal or Disciplinary Events

Swap Financial Group, LLC does not have any legal events or disciplinary history on Swap Financial Group, LLC’s Form MA and Form MA-I, which includes information about any criminal actions, regulatory actions, investigations, terminations, judgments, liens, civil judicial actions, customer complaints, arbitrations and civil litigation. The Issuer may electronically access Swap Financial Group, LLC’s most recent Form MA and each most recent Form MA-I filed with the Commission at the following website: www.sec.gov/edgar/searchedgar/companysearch.html.

There have been no material changes to a legal or disciplinary event disclosure on any Form MA or Form MA-I filed with the SEC. If any material legal or regulatory action is brought against Swap Financial Group, LLC, we will provide complete disclosure to the Issuer in detail allowing the Issuer to evaluate Swap Financial Group, LLC, its management and personnel.

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http://www.sec.gov/edgar/searchedgar/companysearch.html

Issuer Perspective

Patrick J. McCoyDirector of Finance, Metropolitan Transit Authority, New YorkGFOA Past President and Former Debt Committee Member

2.4%

2.5%

11/1/2018 5/1/2019

TBTA Effective FRN Interest Rates

3/1/2019 4/1/2019

67% of SOFR + 50 (2 yr.)67% of SOFR + 43 (1 yr.)

12/1/2018 1/1/2019 2/1/2019

67% of 1m LIBOR + 70 bps (4 yr. put) 67% of 1m LIBOR + 50 (7 yr.)67% of 1m LIBOR + 35 (5 yr.)

Average Interest Rate Over Period:67%of 1m LIBOR + 70 bps: 2.32%67% of 1m LIBOR + 50: 2.12%67% of 1m LIBOR + 35: 1.97%67% of SOFR + 50:2.08%67% of SOFR + 43:2.01%

2.3%

2.2%

2.1%

2.0%

1.9%

1.8%

GOVERNMENT FINANCE OFFICERS ASSOCIATION

REPLACING LIBOR

LEGAL CONSIDERATIONS

Victor Hsu, PartnerNorton Rose Fulbright US LLP

May 21, 2019

WHAT IS A REISSUANCE?• A reissuance is the deemed extinguishment of a debt obligation and the simultaneous issuance of a

new debt obligation in its place• Reissuance for tax purposes occurs when a “significant modification” is made to the terms of a bond• The new modified bond is deemed to have been issued (reissued) in exchange for the old bond• Moving from LIBOR to another index raises the question of whether a significant modification, and thus

a reissuance, has occurred under federal tax law

END OF LIBORTAX MATTERS - REISSUANCE

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IMPACT OF REISSUANCE• If a reissuance has occurred, it is as if the deemed new debt instrument has refunded the existing one,

which generally triggers the need to satisfy all requirements for tax exemption in effect on the date of the reissuance

• Need to conduct new tax analysis and diligence, including use of financed property• Recalculate arbitrage yield• Need to file an IRS Form 8038 for the deemed new issue• True-up on rebate liability, if any, on the issue deemed retired• Bond Counsel to address whether full tax exemption opinion or no adverse tax effect opinion must be

delivered • If a 501(c)(3) financing, need updated due diligence by borrower’s counsel and a new 501(c)(3) opinion• May cause previously integrated swaps to no longer be integrated • Failure to meet all requirements triggered by the reissuance will cause the bonds to lose their tax-exempt

status


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DETERMINATION OF REISSUANCE• When does a reissuance occur? Facts and circumstances test is first instance – whether the

modification is “economically significant”• Treasury Regulation 1.1001-3 contains certain “black and white” rules for determining whether a

modification is significant• In multi-modal bond indenture, is LIBOR an interest rate “mode”? In a variable rate loan agreement, is

LIBOR one of the rate options?• Is the fallback language being used in the document an interest rate mode?• Do the documents provide for the change from LIBOR to another index to be automatic and specific? Or

is it permissive, in the form of an option?• If it is an option, is it treated for tax purposes as a bilateral or unilateral option? Generally, if you have a

unilateral option then you do not have a modification for tax purposes• Recently issued proposed reissuance regulations (Section 1.150-3(c)(1)) provide that an option doesn’t

fail to be unilateral solely because of the holder’s right to put the obligation back to the issuer• Bottom line: Is replacing LIBOR a “significant modification” under Treasury Regulation 1.1001-3?


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IMPACT ON SWAPS• Swaps can serve as qualified hedges under federal tax law, which means that payments under the swap

made or received by the issuer are taken into account in determining arbitrage yield on the bonds• Many swaps that hedge municipal debt are LIBOR-based (e.g., 67% of LIBOR plus 10 basis points)• Changing the variable leg of a swap from LIBOR to another index may trigger deemed termination of the

swap serving as a qualified hedge• Deemed swap termination payment affects arbitrage yield • Reissuance may cause swap to be no longer integrated for federal tax purposes


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IMPACT ON BOND DOCUMENTS AND LOAN AGREEMENTS THAT UTILIZE LIBOR• Two circumstances: (i) Existing “Legacy” Contracts utilizing LIBOR and (ii) New Contracts utilizing

LIBOR, in each case extending beyond 2021• New Contracts can and should include fallback language anticipating LIBOR phase-out• Legacy Contracts often do not anticipate permanent end of LIBOR, but instead only contemplate

temporary interruption of LIBOR quotations

END OF LIBORCONTRACT MATTERS

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• Need to review all legacy contracts to determine impact of LIBOR phase-out Is there fallback language in case LIBOR is not quoted, or is contract silent?

• What are the fallback provisions? Alternative index specified? Who selects the alternative? When is the alternative triggered? Is there an adjustment to the index or spread to correspond more closely to LIBOR?

• If contract does not specify a fallback index, some contracts provide for the LIBOR rate on the last calculation date to be the rate going forward (converting a variable rate obligation into a fixed rate obligation)

• In many loan agreements, there is no alternative index or rate specified, and selection of the fallback index is up to the lender in its sole discretion

• In other loan agreements, the alternative to LIBOR is a rate determined by polling specified “Reference Banks”


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• When does all this matter? When you are stuck with the deal• Many FRN indentures and loan agreements have permissive termination provisions, allowing borrowers

to refinance out of the deal• Make sure the lock-out period (prepayment penalty period) ends prior to 2022• Amendment by mutual agreement is a possibility for loan agreements, direct purchase bond issues and

other bilateral transaction• Amendment of bond indentures more cumbersome

May need majority, super-majority or unanimous consent of bondholders• Amendments can trigger continuing disclosure and rating agency notice requirements


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Panel Discussion and Questions

Tuesday, May 21, 2019Los Angeles, California

Replacing LIBOR

May 19-22, 2019 • Los Angeles, California113th Annual Conference

Learn more by visiting us at gfoa.org • #GFOA2019

Replacing LIBOR• A reissuance is the deemed extinguishment of a debt obligation and the...

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