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LIBOR Problems? We Have LIBOR Answers

On September 3rd, we hit 850 days before the (earliest) potential end of LIBOR. So, what’s in your workflow for the next 850 days? To help you organize, we discuss fallbacks, new SOFR issuances and – critically – how lenders can learn exactly where things stand (and what is happening) with respect to the end of LIBOR.

LIBOR Fallbacks: Good News… and Less Good News

There is good news – and less good news – on LIBOR fallback language in cash products like loans, FRNs and CLOs. On the good news front, it looks like most cash products are now including fallback language in new deals. This is critical because many instruments will be outstanding when LIBOR ends after 2021, and if they don’t have good fallback language, there could be contract frustration (and litigation). However, on the less-good-news front, the fallback language is not always consistent (which may lead to a lot of work to determine exactly how each instrument would fall back) or workable en masse (which may lead to traffic jams as everyone tries to amend their deals at the same time). We discuss the fallback status of FRNs and loans below. (And we’d gently remind readers that several CLOs have gone “hardwired”, per LCD and Covenant Review).

SOFR: Fallback Roadblocks Falling?

As the nearby story reports, we are quite excited to see a new CLO with “hardwired” LIBOR fallback language. (Hardwired fallback language is what is being used in FRNs, and generally states that, upon LIBOR cessation, the contract falls back to a version of SOFR plus a compensating spread adjustment.)

LIBOR Fallbacks: Are Loans and CLOs Aligned?

There are $1.2 trillion of institutional loans outstanding, and nearly $700 billion are housed in CLOs. When the reference rate of loans and CLOs are not aligned, basis risk emerges. This was notable – and painful for equity – in 2018 when the 1-month/3-month LIBOR curve steepened to 50 bps and corporate borrowers switched to one-month LIBOR while CLO liabilities continued to reference three-month LIBOR. But basis risk doesn’t stop there; it is an issue to be considered with LIBOR fallbacks as well.

LIBOR Fallbacks: Syncing Loans and CLOs

As even most grandmothers now know, LIBOR – the world’s most important number – may end after 2021. For this reason, responsible loan market participants are preparing for a transition. Step One: Ensure you have robust and actionable LIBOR fallback language in your loans and CLOs. Step Two: Recognize that loans and CLOs likely will have slightly different fallback language, and prepare for the hopefully modest risks that raises. Below we flag potential differences so lenders can prepare.

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