March 2, 2020 - On February 26th, the LSTA distributed a revised draft of the LSTA’s Compounded SOFR in Arrears concept credit agreement to the Primary Market Committee and SOFR Working Group. A summary of the key changes is set forth below. (A discussion of the initial draft is available here.)
1. Non-SOFR related changes. Conforming changes to bring this document in line with the form of Investment Grade Term Loan published in January, the inclusion of the updated bail-in language set forth in the LSTA advisory dated January 31st and new language in Section 8.07 “Non-Reliance on Agents and Other Lenders”.
2. ABR Definition. A SOFR prong has been added referencing the 30-day Average SOFR that will be published by the NY Fed starting on March 2nd. Parties will need to specify the appropriate margin to be included. The new language includes the SOFR prong, related definitions, corresponding updates to Section 2.18 “Illegality” and a provision in Section 2.20(e) to address unavailability of this SOFR prong.
3. Transition to Term SOFR. Members indicated a desire to transition to Term SOFR if one were to exist and be available for use in syndicated loans. We have included bracketed language to provide for that transition. We encourage you to pay specific attention to FNs 5 and 32 as well as the definitions of “Term SOFR” and “Term SOFR Transition Event”. We welcome specific feedback on whether and how this ability should be included, including whether the transition to Term SOFR should instead be an opt-in process (and effected through a streamlined amendment process).
4. Early Opt-in Trigger for Future Transitions. We received conflicting feedback on whether an early opt-in trigger would be appropriate for use in an (unlikely) potential transition away from “Compounded SOFR” if it were to be discontinued. We have included the relevant language in brackets with an explanatory footnote.
5. “Compounded SOFR” Definition. We have made a couple of clarifying changes as well as updating the text in the footnotes to this definition, for instance, to reflect the NY Fed’s recent statement on the publication of SOFR Averages and SOFR index. We have deleted the footnote highlighting the preference for a “Compounded SOFR” screen rate as it is unlikely such a screen rate would be available and usable for calculating interest in syndicated loans.
6. “Interest Period” Definition. We have included a footnote that parties can consider additional Interest Periods as they see fit. The drafting offers bracketed 1M/30 days and 3M/90 days Interest Periods. For longer Interest Periods, parties would need to consider the interest payment frequency and related mechanics.
7. “Observation Period” Definition. The concept credit agreement currently uses a lookback with observation shift convention to allow for the amount of interest due to be known before the end of the Interest Period. We note in FN 25 that with the lookback with observation shift, in its current form, the number of actual days a loan is outstanding may differ from the number of days in the Observation Period. One potential solution is to use a calendar-day lookback with an imputed SOFR for any start date for an Observation Period that is not a Business Day. Implementing this solution would require modifications to the “Compounded SOFR” definition and related definitions.
Alternative “in arrears” conventions include a lookback without observation shift (which would make the use of an index challenging), a payment delay (i.e., the payment is made after the Interest Period) and/or a lockout (i.e., a certain day’s rate, e.g. two days before the end of the Interest Period, is then “locked” and repeated as the relevant SOFR for the final two days of the Interest Period). Discussions in the ARRC Business Loans Working Group on identifying a recommended convention for syndicated loans is ongoing.
8. Notice Periods. We have left notice periods blank for drafters to complete, however, we note that parties may consider syncing the length of the lookback to the timing requests for Borrowing Requests (in Section 2.03(a)) and prepayment notices (in Section 2.06(c)) to mitigate arbitrage opportunities.
9. Section 1.04, “Rates”. We received some clarifying comments which have been incorporated.
10. Section 2.06(e), “Prepayments”. We clarified that prepayments are to be applied first to interest and then to principal.
11. New Section 2.14, “Compensation for Losses”. We have included a bracketed provision designed to allow for lenders to recoup losses in the event of an intra-period prepayment. As noted initially, customary LIBOR break funding provisions do not neatly translate in the context of a daily rate, however, discussions around lenders’ cost of funding and breakage indemnities remain an open discussion point in the market. The provision is modeled on a provision that is sometimes seen in LIBOR-referencing credit agreements today and incorporates the relevant portion of language from existing LSTA forms.
As our members undertake their review, they are encouraged to keep in mind that this concept document does not purport to represent or set any standard market practice. It has been developed simply as a tool to further familiarize market participants with replacement benchmark alternatives, in this case Compounded SOFR in Arrears, which will hopefully further assist each institution with its own transition planning. We plan to distribute the initial draft Simple SOFR in Arrears version in early March.
For more information, please contact Tess Virmani.