LIBOR Transition Update | Proskauer Rose LLP
This LIBOR transition update, aimed primarily at private credit lenders, provides a recap of recent trends and reflects new developments on the eve of the LIBOR transition for banks, including new SOFR issues by lenders. credit and the context around âspread adjustmentsâ. We are actively monitoring developments in the LIBOR transition and will continue to provide relevant updates.
deadline of December 31, 2021; Relevant regulations
As readers are no doubt aware, the federal regulators of the affected banks, in consultation with the administrator of LIBOR and various state agencies, have made it clear that the banks they regulate must stop granting new grants. LIBOR-based credit extensions by December 31, 2021..
In anticipation of this deadline, several investment banks have, in recent weeks and months, set up new syndicated credit lines based on alternative reference rates (mainly the SOFR). As the new year dawns, we expect the vast majority of syndicated credit facilities will be based on alternative benchmarks like SOFR.
Direct lenders are generally not subject to banking regulations and do not fall under the jurisdiction of the agencies which set the deadline on December 31. Therefore, in discussing LIBOR succession with many of our clients throughout the year, we do not anticipate an immediate transition to SOFR (or any other alternative benchmark rate) by private lenders in 2022. However, many direct lenders may be subject to other regulatory scheme, including, for example, regulation by the SEC, an agency that has made clear its concerns about LIBOR. For this reason and for some of the reasons we describe below, we anticipate that direct lenders will likely provide an increasing number of SOFR-based loans in the coming months.
LIBOR Replacement Documentation
As direct lenders continue to prepare to issue new loans on the basis of alternative benchmarks, we have continued to observe a general tendency to include a “hard-wired” replacement language for “fallback” LIBOR in the documentation of LIBOR. credit. As a reminder, there are generally two options for addressing LIBOR succession in credit agreements: the âhard-wired approachâ, which provides for automatic replacement of LIBOR by SOFR upon certain trigger events, and the âhard-wired approachâ. amendment â, which is in effect anâ agreement to agree âgiving the agent the power to modify the document to replace LIBOR, if necessary, subject to the consent of the borrower, and often with the rights of consent negative lender required. A considerable number of private lenders now favor the hard-wired approach in LIBOR credit facilities (but see our notes below regarding âspread adjustmentsâ in the hard-wired documents).
SOFR issuance by private lenders
With the advent of new SOFR-based syndicated credit facilities, SOFR termsheets, funding grids, letters of commitment and credit agreements are also making their way into the private markets. (To be clear, as noted in previous bulletins, the trend towards SOFR as opposed to other alternative benchmarks is strong at this point, and we are aware of very little, if any, of credit facilities based on non-SOFR alternatives in private markets). We have seen a noticeable (although still modest) increase in SOFR emissions (or a proposed SOFR emission) in recent weeks. We expect this trend to continue and likely increase in 2022, for several reasons.
First, any private credit lender considering participating in a junior tranche of capital (a second lien, for example) in a structure in which the senior tranche is syndicated or otherwise provided by a bank will likely be under some pressure to provide a system based. on SOFR. ready, since the senior tranche will almost certainly be SOFR-based. While it is possible to fork the benchmark rates (and, indeed, we know of at least one credit facility in which the revolving commitments were based on SOFR and the term loan was based on LIBOR), we expect most borrowers to insist on a single rate. through the slices for ease of administration.
Second, many direct lenders enter into leveraged or subscription credit facilities themselves as part of their overall strategy. Any such facility provided or arranged by a regulated bank (i.e. the vast majority of them) and concluded after December 31 will be SOFR based. A lender with a SOFR-based leverage facility but a predominantly LIBOR-based loan portfolio may be subject to risk management issues caused by this mismatch between liabilities and assets, and these challenges could lead to an increase SOFR emissions.
Third, as interest rates rise over time, borrowers may become more likely to enter into interest rate swaps and hedges, which (given the LIBOR derivatives market’s own transition ) may further incentivize loan market participants to switch to SOFR.
Finally, direct lenders will be subject to the same macroeconomic trends that led to the departure of LIBOR. As noted above, regulatory pressure may continue to increase and lenders may have concerns (or their investors may have concerns) about the contracting LIBOR market and the inherent instability of LIBOR which initially led to a downturn. new rate.
Of course, at the end of the day, the question of the private credit market’s transition out of LIBOR is a question of timing. As readers know, the final deadline for LIBOR is June 30, 2023, after which it will no longer be published, and all new and existing credit facilities will have to move to another benchmark rate before that date.
A few words on spread adjustments
Spread adjustments, the precise mechanisms of which we discussed in our previous bulletin, are designed to compensate lenders for the difference between LIBOR (an unsecured, “credit-sensitive” rate) and SOFR (a guaranteed rate that s ‘is historically traded at a discount to LIBOR).
For new SOFR-based loans, the syndicated market has seen several different approaches taken on spread adjustments. One approach has been to apply a spread adjustment of 10 basis points for one-month SOFR, 15 basis points for three-month SOFR and 25 basis points for six-month SOFR. Another approach has been to set the price without any spread adjustment, but instead include the economics of the spread adjustment directly into the margin. We expect to see additional options tested in the market as the transition begins in earnest. As SOFR loan issuance in the private market increases, we expect to see the same exploration price there as well.
For new LIBOR-based loans with a hard-wired fallback language, the standard language published by the Alternative Reference Rates Committee contemplates spread adjustments of around 11, 26 and 42 basis points for maturities of one, three and six months, respectively. (This is the same spread adjustment recommended by ISDA). The last few months have also been marked by negotiations around these spread adjustments, although the recommendations of the ARRC remain common in the market.
Key points to remember
As the LIBOR transition continues, private lenders should:
- perform a portfolio review to understand the transition and / or fallback language in existing credit documents (keeping in mind the final deadline to modify existing LIBOR transactions in June 2023);
- consider formulating a fallback language policy for new LIBOR-based transactions (including spread adjustments);
- prepare commercial, legal, operational and agency functions for new SOFR issues; and
- continue to closely monitor the issue, including its development in syndicated markets.
We continue to monitor this issue closely and will provide additional updates as needed.