By John Hintze
Concerns remain about the risk-free secured overnight financing rate plummeting during periods of market stress, just as banks’ funding costs increase. Potential solutions to mitigate that risk have yet to gain traction, although recent developments with the remaining credit-sensitive reference rates, Ameribor and the Across-the-Curve Credit Spread Index, could spark growing interest.
Reference-rate pioneer Richard Sandor launched the American Financial Exchange in 2015 to enable lenders to lend and borrow short-term funds among one another. Ameribor is generated from those transactions and financial institutions’ other sources of unsecured costs, and AXI’s approach is similar conceptually if different in practice. Both floating-rate reference rates reflect credit risk, unlike SOFR, a secured rate calculated from the gigantic U.S. Treasury overnight repurchase-agreement (repo) market.
Lenders like a credit-risk component, previously provided by Libor, the rate SOFR and the other reference rates were designed to replace, because it allows them to match their assets and liabilities more efficiently. In times of market stress when lenders’ funding costs increase, so will the reference rate over which they price their loans. Risk-free SOFR, instead, may fall as investors seek safety in Treasury bonds, squeezing that asset-liability spread — every bank’s bane — and likely resulting in borrowers drawing down committed credit lines.
“We still have concerns, but we don’t have a good [mitigation strategy] right now,” says the treasurer of one of eight large regional banks that penned a letter to regulators in September 2019. The letter expressed support for SOFR as well as their concerns about the risk-free rate, including reducing banks’ willingness to lend in times of stress.
Credit-sensitive hurdles
Despite its credit sensitivity, however, Ameribor has yet to gain a significant user base, in part because federal regulators emphatically supported SOFR to ensure a successful transition away from LIBOR in June 2023. The next month, the International Organization of Securities Commissions raised concerns about the robustness of new credit-sensitive rates, without specifically naming Ameribor. Later that year, Bloomberg announced the cessation of its BSBY credit-sensitive rate that several large financial institutions had begun using.
Until recently, market volatility was subdued and there’s been little discussion about banks’ potential balance-sheet peril in volatile times or the credit-sensitive rates that could cushion shocks. “We are no longer using Ameribor for lending benchmarks,” the regional bank treasurer says. “We offered it for a while, but there was no customer uptake.”
AXI finds new uses
The SOFR Academy launched AXI in 2022, and it, too, has yet to gain significant traction. Marcus Burnett, founder and CEO of the SOFR Academy, says that banks have expressed interest in referencing AXI for SOFR-based commercial lending, including revolving lines of credit. He declined to say whether AXI is currently being used in that context but noted an April 7 meeting convened by the SOFR Academy whose attendees included representatives of the Federal Reserve, FDIC and Commodity Future Trading Commission. The meeting minutes show attendees discussing Europe and China retaining credit-sensitive rates, as well as bankers’ hesitancy to adopt new credit risk-management tools such as AXI without clarity from regulators as to their viability.
Burnett noted, however, that reference-rate is garnering interest in other ways.
“Certain large Wall Street banks desire a credit-sensitive element to trade derivatives with their hedge fund clients; for example, to speculate on credit conditions,” Burnett says. “SOFR is risk-free, so [it] doesn’t give them that ability.”
And some banks have started using it internally as well. The minutes of a Jan. 30 online meeting organized by law firm Sullivan and Cromwell to discuss the application of AXI and its sister reference rate, the Financial Conditions Index, note that large banks “have begun ingesting and using AXI data primarily to enhance treasury functions by incorporating a credit-sensitive element to reflect the bank’s funding costs more accurately.”
Credit volatility looms
The interest in AXI arrives as tariffs fuel credit volatility and a possible recession looms. Key to a credit-sensitive rate is whether it widens when credit risk jumps, such at the start of the covid epidemic or in spring 2023 when Silicon Valley Bank and other regionals entered receivership.
“If you look at AXI or FXI, they did go way up during those events — that’s what I would be looking at if I were a bank manager, either making loans or transferring risk with a derivative,” says Darrell Duffie, a professor of finance at the Stanford Graduate School of Business.
Duffie is one of three authors of a paper published by Stanford in July 2023 that provided a conceptual basis for AXI, which he says is unlikely to raise regulators’ concerns about its robustness because it captures all publicly available funding transactions across the credit curve, from overnight to five-year borrowings.
“Our idea was to not leave anything to chance,” Duffie says. “If banks are using longer-term funding instead of three-month funding, that will be reflected in the AXI fixing, because it weighs according to issuance and volume.”
In February, Duffie shared authorship on an article in the Journal of Finance, titled, “Bank Funding Risk, Reference Rates, and Credit Supply.” It demonstrates how credit-sensitive rates increase the willingness of banks to offer credit lines to borrowers, because credit sensitive rates reduce borrowers’ incentives to draw on committed credit lines when banks’ funding costs are high.
Ameribor’s new owner
Ameribor may also see a boost after its recent acquisition by the Intercontinental Exchange, the owner of the New York Stock Exchange and the administrator of several reference rates. In a Jan. 8 statement by the ICE, Carsten Kengeter, CEO of 7RIDGE, which had acquired AFX in 2023 and sold it to ICE, notes: “We are confident that ICE’s leadership will amplify AFX’s success and its purpose to serve regional and local American banks by creating a transparent, robust and efficient interbank ecosystem.”
In the same statement, Christopher Edmonds, president of ICE fixed income and data services, describes the acquisition as “complementing our leading global index business and our best-in-class mortgage technology network” and a natural fit to ICE.
“We look forward to continuing to serve this important market, delivering innovation and new product development made possible through the addition of AFX to our portfolio,” Edmonds notes. An ICE spokesperson declined to elaborate on the company’s plans for AFX.
ServisFirst Bancshares, a $17.35 billion-asset bank headquartered in Alabama, has offered Ameribor as well as SOFR and the prime rate to commercial customers for several years and continues to do so. Rodney Rushing, COO at ServisFirst, says Ameribor and SOFR have closely tracked each other, but the bank’s preference is Ameribor because of its credit-risk component.
“So far we have not had a recent credit issue that has made the credit component come into play,” Rushing says.
He added ServisFirst is not aware of plans or details ICE may have due following their acquisition of AFX and Ameribor, but should the reference rate go away, the documentation of any loan priced over Ameribor stipulates transferring the interest-rate benchmark to a comparable index.
Ethan Heisler, editor of the Bank Treasury Newsletter and a former managing director at Citigroup, agrees that a credit-sensitive rate would benefit the banking industry, especially for community banks that generate much of their income from lending. “But here’s where it gets trickier,” he says. “How much do they want to spend?”
There’s typically a fee to use reference, which banks may opt to avoid if they have free access to the prime rate set by the Federal Reserve, although the Fed resets prime every six weeks, putting banks at risk if there is a sudden credit crisis. Burnett says that AXI licensing fees are currently being waived for all users.
Contributing editor John Hintze is a financial journalist who writes frequently for the ABA Banking Journal.
