January 26, 2021 - Last week, the New York State 2022 budget was presented, and included the ARRC’s proposed LIBOR transition legislation (in Article 18-c). We describe the impact briefly below, but note several items upfront. First, the legislation generally would not apply to most loans as they are safe-harbored because they ultimately “fall back” to a non-LIBOR rate in the form of Prime. Second, the legislation would apply to most (pre-2H17) CLOs because they would ultimately fall back to last quoted LIBOR. Third, the impact on CLOs may be muted with the anticipated extension of most USD LIBOR tenors to June 30, 2023 for legacy products. And now, into the weeds!
The ARRC’s proposed LIBOR legislation applies to contracts that do not have fallback language or that fall back to a rate based on LIBOR (such as last quoted LIBOR). Under the legislation, these contracts would instead fall back to the “recommended benchmark replacement”, which is a “benchmark replacement based on SOFR, which shall include any recommended spread adjustment and any benchmark replacements conforming changes that shall have been selected or recommended by the relevant recommending body.” The relevant recommending body is the Federal Reserve Board, the FRBNY or the ARRC.
Importantly, the legislation excludes contracts that would fall back to a rate that is not based on LIBOR, such as Prime or Federal Funds. Thus, because most loans ultimately fall back to Prime, they are specifically – and intentionally – excluded from the legislation.
CLOs would be included in the legislation if they have no fallback language or fall back to last quoted LIBOR, which mostly covers CLOs originated in the first half of 2017 or earlier. (In July 2017, FCA Chief Executive Andrew Bailey announced LIBOR cessation for cash products and CLOs began introducing LIBOR fallback language.) That pre-2H17 vintage of CLOs could benefit from the legislation. However, it is a small cohort of CLOs, with just $54 billion outstanding today, according to Nomura. Moreover, based on FCA and Ice Benchmark Administration (“IBA”) announcements from November 2020, most market experts expect most USD LIBOR tenors to continue for legacy products until June 30, 2023. At that point, the legacy CLO problem should be modest – Nomura estimates just $31 billion – as nearly all of the pre-2H17 CLOs are likely to have been called, refinanced or reset by then.
While loans are excluded and CLOs should be only modestly affected, to further minimize the impact on CLOs, the LSTA did support and sign SIFMA’s letter supporting the ARRC New York State Legislation; we believe that anything that smooths LIBOR transition and reduces the potential for market disruption is A Good Thing.