Bank of America announced Monday that it will take a $1.6 billion non-cash charge in the fourth quarter as it transitions away from using the London Interbank Offered Rate (LIBOR) as a reference for various financial instruments. The charge comes as regulators globally move to phase out the use of LIBOR by the end of June 2023.
Transitioning Away from LIBOR
LIBOR has historically been used as a benchmark for various short-term borrowing rates and underpins trillions of dollars worth of financial contracts. However, after allegations of rate manipulation, regulators have been pushing the finance industry to transition to alternative reference rates.
Bank of America said in an SEC filing that the $1.6 billion pre-tax charge is tied to the “cessation of the issuance of overnight indexed swap (OIS) rates based on the BSBY rate.” Instead, the bank will transition newly issued derivatives to using the Secured Overnight Financing Rate (SOFR).
SOFR is seen as a more reliable reference rate and regulators have designated it as the replacement benchmark for USD LIBOR. The switch by Bank of America aligns with the institution’s broader move away from LIBOR.
While the $1.6 billion charge is non-cash, analysts say it will still negatively impact Bank of America’s fourth-quarter profits.
|Expected to decline by up to 14%
|Q4 Earnings Per Share
|Forecast down 8-12 cents to $0.75-$0.79
Lower profits stem both from the charge itself as well as from an anticipated reduction in net interest income tied to the terms of replacement contracts.
Bank of America said it expects “low single-digit billions” of loans and derivatives will transition from using LIBOR in 2023. This represents about 5% of total outstanding contracts.
The move by Bank of America is one of the largest charges announced thus far related to LIBOR transition. Analysts say it signals the significant impact the reference rate changes are having across banking.
“This accounting charge speaks to the complexities of withdrawing LIBOR,” said Brian Kleinhanzl, an analyst at Keefe, Bruyette & Woods. “There will be pressure on net interest income as contracts get amended.”
While painful in the short term, most experts agree that moving the financial system off of LIBOR is necessary. The Alternative Reference Rates Committee and other regulators continue to push the timeline to ensure orderly transition by the end of June 2023.
“The cessation of LIBOR is messy, complex and costly,” said Ian Katz, an analyst at Capital Alpha Partners. “BofA said the $1.6 billion charge would help it transition large parts of its balance sheet ‘to more durable reference rates.’”
With under 18 months to go, financial institutions are expected to accelerate their transitions in 2023. More charges and hits to profitability are likely as existing contracts are amended and new SOFR-based derivatives are issued.
However for Bank of America, analysts say the bulk of the financial impact has now likely been realized.
“Today’s charge draws a line under the transition and means the bank will have less drag from LIBOR cessation going forwards,” said Betsy Graseck, an analyst at Morgan Stanley.
Nonetheless, the scale of Bank of America’s charge shows the monumental effort still facing the industry as the clock winds down on LIBOR.
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