Debt markets ready to rush to LIBOR finish line

Nearly half of the $1.4tn US junk loan market is still locked to Libor 30 days before the rate expires, with little trading activity on the ability of companies to break away from the lending benchmark and embrace its replacement. There is a curb.

Slower-than-expected progress means corporate borrowers and institutions facilitating the switch to the new benchmark face a crunch point, as they attempt to push loans over the line past the cut-off, in order to potentially to avoid falling back automatically when less than Favorable credit terms.

At least $700 billion worth of low-grade corporate debt is still rated using LIBOR, according to industry participants’ estimates, despite years of warnings that the rate would expire this summer. Moody’s has put the percentage outstanding as of May 19 – at around 60 per cent or $900bn based on loan portfolios rated by the agency – even higher.

The rest of the market is moving to the newly accepted benchmark in the US known as the “Sofer”, the secured overnight financing rate, and the pace of transition has accelerated in recent months. But with the clock ticking for residual debt till June 30, flows are hampered by economic and market stress.

David Ridley, Partner, said: “I expect everyone across the spectrum – banks, law firms, private equity firms and their portfolio companies – will be affected and do what they can to transform their portfolio of deals by the end of the month. Will be busy doing that.” at law firm White & Case, pointing to “a lot of paperwork”.

Meanwhile, fresh borrowing in the sub-grade debt market has been “significantly weak” this year, according to Lotfi Karoui, chief credit strategist at Goldman Sachs.

“In an ideal world, you’d want a large portion of the transition to be through refinancing, where you’re replacing some of these older loans that reference LIBOR with new ones,” Karaoui said. “In a more robust primary market environment, things happened organically.”

White & Case’s Ridley agreed that “the natural opportunity for transition through a few large transactions . . . effectively dried up over the past year”.

The abolition of the daily publication of the US dollar version of LIBOR is seen as the last hurdle in moving away from the lending rate, which was used to price various assets for decades, but which was used after the 2008–09 financial crisis. Manipulation was central to the scandals.

On Wednesday, the UK’s Financial Conduct Authority reiterated that US dollar LIBOR would expire in one month and that all new use of the remaining dollar LIBOR settings, other than the synthetic rate, “shall be prohibited”.

The transition to Sofr has been slowed this year by tensions between corporate borrowers and their debt holders, most of whom are “collateralized debt obligations” — vehicles that scoop up loans, sort them into risk categories and sell tranches to investors. Are.

Arguments have centered on the differences between the old and new lending benchmarks. LIBOR is understood to contain an underlying credit risk premium that the SOFR lacks, prompting lenders to argue that loan modification documents should offer the SOFR plus some additional compensation.

However, companies already face very high funding costs, because “leveraged loans” typically have floating rates – meaning their coupons have risen higher as the Federal Reserve raised interest rates. Is. In turn, many have pushed against suggested “credit spread adjustments” that could increase payments following the SOFR switch.

But the focus has shifted towards getting things done faster. Many companies have fallback plans, but these are not necessarily attractive options.

According to an analysis by research group Covenant Review based on the Credit Suisse Leveraged Loan Index, more than two-thirds of loans linked to LIBOR have “hard-wired” language in their documents, meaning they will automatically be automatically repaid come July 1. Will come back to the mentioned guidelines. by the Alternative Reference Rates Committee – a team of market participants convened by the New York Fed.

The ARRC suggests a series of “Sofr Plus” adjustments to loan documents for various loan disbursement timelines. Borrowers with hard strings may come back on those terms as long as they don’t try to rush deals through with small adjustments.

Other loans have a variety of language to aid in the switchover process. But a small group – 8 percent of the market linked to LIBOR – have no succession language in their documents. This means they could fall back to the even more expensive “base rate” if they don’t transition to Sofr in time.

For Tal Riback, a principal at private equity firm KKR who is on the ARRC board, “It is not a moment to panic as the market has proved to be very orderly – given the pace of the correction in April and May, there has been a lot”.

But LIBOR’s deeply entrenched nature still makes the transition challenging after such a long period of use.

“Liber is like salt. It’s in everything – it’s very difficult to get it out after cooking. But what you’re seeing is a whole new buffet,” she said.

Additional reporting by Nico Asghari in London