Letters ‘encourage’ credit unions to stop using LIBOR as soon as possible

Stopping the use of LIBOR as a reference rate as soon as possible as a year-end expiration date of the rate looms is encouraged for all federally insured credit unions, their federal regulator said in letters released Monday.

In the first letter, the National Credit Union Administration (NCUA) said failure by credit unions to prepare for disruptions of the London Interbank Offered Rate (LIBOR) “could undermine a federally insured credit union’s financial stability, and safety and soundness.”

LIBOR is a reference rate used by many financial institutions – including credit unions – to set rates on such financial products as adjustable mortgages and student loans (which NCUA said “make up a significant portion of LIBOR-indexed loans owned by credit unions.”) The rate is scheduled to be phased out at the end of this year (legacy contracts using the rate are scheduled to stop using the rate by mid-2023) because assumptions it uses have become unreliable in reflecting current economic and financial conditions.

“The LIBOR transition is a significant event that credit unions should manage carefully,” the letter, signed by NCUA Board Chairman Todd Harper, states. It notes that the Federal Financial Institutions Examination Council (FFIEC) has issued a statement which recommends that new financial contracts use a reference rate other than LIBOR or have robust fallback language that includes a clearly defined alternative reference rate after LIBOR’s discontinuation.

Harper said the second letter released Monday by the agency, a “Supervisory Letter” (SL No. 21-01 – the first of the year), “provides the supervision framework examiners will use to evaluate a credit union’s risk management processes and planning regarding the transition from LIBOR.” The guidance in that letter, Harper stated, applies to all federally insured credit unions.

The supervisory letter, which outlines the background, potential LIBOR exposure for credit unions, and examination considerations, also offers no endorsement of a specific replacement for USD LIBOR. (That includes use of the Federal Reserve-developed Secured Overnight Financing Rate (SOFR), which was created specifically as a replacement for LIBOR.)

“A credit union may use a reference rate for its loans and member shares that it determines is appropriate for its risk management and member needs,” the supervisory letter states. “All LIBOR-based contracts that mature after December 31, 2021 (one-week and two-month) and June 30, 2023 (one-, three-, six- and 12-month) should include contractual language that provides for use of a robust fallback rate.”

NCUA Letter to Credit Unions 21-CU-03: LIBOR transition

NCUA SL No. 21-01: Evaluating LIBOR Transition Plans