October 7, 2021 - by Meredith Coffey. We heard that October would be a pivotal month in LIBOR transition – and we weren’t wrong. We detail regulatory pronouncements, market activities and lender to-do’s below.
On the regulatory front, at SF Vegas, Fed Vice-Chair Quarles hammered home that new LIBOR originations must end in 86 days. And don’t wait that long! He added, “[L]enders will have to pick up the pace, and our examiners expect to see supervised institutions accelerate their use of alternative rates.”
Quarles noted that Term SOFR is ready to go, adding that “it is critical that capital markets and derivatives markets transition to SOFR.” However, he acknowledged that traditional bank loans raise different issues, and reiterated that a “bank may use SOFR for its loans, but it may also use any reference rate for its loans that the bank determines to be appropriate for its funding model and customer needs.” But he also warned that parties should understand reference rate construction and fragilities – and build in fallbacks. Our interpretation: BSBY, Ameribor, CRITR, BYI and AXI may well be on the table for regular-way bank loans, but entities must understand and be prepared to defend them. And it is happening: Bloomberg has several BSBY-based loans, most notably a $2.3 billion revolver and term loan series for high-grade corporate Knight-Swift Transportation.
Meanwhile, public SOFR loans are emerging in the leveraged market. Several weeks ago, Sanderson Farms headlined as the first US BSL pro rata SOFR loan and institutional loan that flips from LIBOR to SOFR. This week, the market is buzzing about the $600 million Walker & Dunlop loan that is priced on Term SOFR (SOFR+10 bps CSA+margin). As discussed in Bloomberg, it is a milestone event in the loan space, even if it’s not Dow 36,000. We also hear there are more SOFR loans in the queue. Thus, it behooves lenders that are not up to speed on SOFR – or on what they must do to prepare for SOFR – to get moving. Here are several issues to consider:
Spread Adjustments: There is some confusion about the use of ARRC Recommended Spread Adjustments for fallback loans (11.4 bps for 1M, 26 bps for 3M) vs spread adjustments on new loans. The ARRC’s recommendations apply only to “USD LIBOR contracts that have incorporated the ARRC’s recommended hardwired fallback language or for legacy USD LIBOR contracts where a spread-adjusted SOFR can be selected as a fallback.” The ARRC has not recommended that these spread adjustments apply to new loans. Thus, the fact that new loans may emerge with spread adjustments that are lower than 11.4 bps/26 bps does not conflict with the ARRC’s recommendations. (The LSTA has published and podcasted on the “spot spread” vs historical spreads.)
Systems: As the Walker & Dunlop and Sanderson Farms loans demonstrate, new SOFR loans may emerge with a “three-field” pricing mechanic: SOFR+credit spread adjustment+margin. In addition, credit spread adjustments likely will be negotiated – so they will not necessarily all be the same – and it’s possible that there will be different spread adjustments for 1M and 3M interest contracts. It is important that lenders ensure that their systems can handle all these interest rate permutations. In addition, if investors are buying a loan in the secondary, they should be aware of the reference rate (LIBOR? SOFR? BSBY? Other?) and any spread adjustment.
CME Term SOFR Licenses: At the risk of being mistaken for a broken record, we again reiterate the importance of lenders/investors obtaining a CME Term SOFR License. The license is free, but the ARRC recommended term SOFR – which is what will be used in term SOFR-based loans – was developed and is owned by the CME and needs to be licensed. The LSTA has posted and podcasted on this issue.