July 26, 2021 - Usage of ARRC Hardwired Fallbacks has grown significantly in recent months – building on the increased momentum we had already seen in 2021. Covenant Review recorded close to 90% of new syndicated institutional loan originations that came to market in June (and over 88% of new originations in May) with ARRC Hardwired Fallbacks. Looking at the last nine months – since the ARRC recommended that no new loans should be originated without hardwired fallback language – the progress has been striking. Covenant Review noted that the “rate of uptake has grown steadily from about 30% of deals that came to market in October to December 2020 and about 60% of the new issue market for January to April 2021.” The data seems to indicate that the prudential regulators’ supervisory guidance in late 2020 calling for new LIBOR loans to have hardwired fallbacks certainly played an important part in furthering adoption and the trend is clearly in the upward direction.
So, if we assume that ARRC Hardwired Fallbacks continue to dominate new originations through the end of the year, what can we glean about the replacement of LIBOR for institutional loans?
ARRC Hardwired Fallback language has “Term SOFR” (a forward-looking SOFR term rate recommended by the ARRC) as the first step of the benchmark replacement waterfall. Despite some hiccups along the way, it seems the ARRC is days away from recommending CME Term SOFR Rates. This recommendation would mean that any institutional loan with ARRC Hardwired Fallbacks will transition to Term SOFR after June 30, 2023 if not earlier as agreed by the transaction parties. The plot has thickened, however, because some ARRC Hardwired Fallbacks have included an additional early opt-in trigger that is not part of the ARRC recommended language. Covenant Review noted that a significant minority of new loans (over 20% in May and June) would allow for a transition to a credit sensitive rate ahead of USD LIBOR’s demise if the borrower and administrative agent elect to do so and objection from Required Lenders is not received within five business days. That is certainly a noteworthy number, but its significance pales as one looks at the broader universe of loans with ARRC Hardwired Fallbacks. In that context, only 7% of loans with ARRC Hardwired Fallbacks include this modification. With five months left of LIBOR runway for new loans, based on the current trajectory, it seems unlikely that a large percentage of loans with ARRC Hardwired Fallbacks will include this modification.
Despite the dominance of ARRC Hardwired Fallbacks lately, many outstanding loans have Amendment Fallbacks. Covenant Review found about 20% of syndicated institutional loans in the CS Leveraged Loan Index include the ARRC Hardwired Fallbacks which means that around 80% of the CS Index will need to be refinanced or undergo an amendment process to replace LIBOR. Of that 80%, about 60% require that the administrative agent and borrower give due consideration to the “evolving or then prevailing market convention.” What that convention will be – or if there will be only one – at the time of amendment remains unknown.