Loan market to be repriced if Libor is replaced

LONDON, July 27 (LPC) — A staggering $4 trillion in outstanding syndicated loans may need to be repriced if Libor is discontinued, as replacement rates could be significantly lower than the existing benchmark.

Libor provides an interest rate benchmark for almost all syndicated loans, FRNs and derivatives, as well as intercompany loans and other types of commercial contracts.

Its replacement will affect all loan contracts and make it more difficult for treasurers to calculate their borrowing costs.

“This is a serious cash management problem for businesses,” said a loan syndicator.

Since banks were found to be manipulating Libor bids before, during and after the financial crisis, regulators have pushed to replace Libor with replacement rates based on real transactions and less open to market abuse. .

They have set a deadline of the end of 2021 to find a suitable Libor replacement.

Libor is likely to be replaced by risk-free rates such as the Secured Overnight Funding Rate for US dollar loans and the unsecured Sterling Overnight Index Average for sterling loans.

The Libor is a forward-looking forward rate based on one, three, six and 12 month contracts. It provides certainty about financing costs, as interest payable and term are known in advance, and also offers lenders premiums for longer-term maturities.

Currently, the new RFRs are retrospective overnight rates, which do not take into account the cost of funds or the credit risk of banks. They also do not compensate lenders for the duration of the contract and are priced below Libor. MIND THE GAP The spread in rates and lack of detail will make it harder for corporate treasurers to forecast the cost of their debt and match funding, bankers said.

“It’s certainly not ideal. Lenders and borrowers need to know how much will be paid on a loan. It’s important for cash management,” said a senior banker.

Based on historical data calculated by the Federal Reserve Bank of New York and cited in a Fitch Ratings report, SOFR could be 75 basis points lower than Libor, requiring higher loan prices to sustain yield. initial of a loan.

Borrowers and lenders have already amended existing credit documents to include Libor replacement language ahead of the 2021 deadline.

While the amendments provide a mechanism for establishing new base rates, they do not effectively address the credit line revisions that will be required, Fitch said. COMPLICATED The Libor replacement process is complicated by the fact that credit agreements and lenders have different levels of consent rights that must be agreed when the agent banks and borrowers agree on a revised base rate.

Lenders often have negative consent rights to revised base rates and are deemed to have accepted the new rate if they do not object within a limited time. Lenders also sometimes have additional consultation rights.

In a rising interest rate environment, some banks could try to use their consent rights to reprice loans at even higher levels, which could put lenders without consent rights at a significant disadvantage in negotiations, said said Fitch. WORK IN PROGRESS In Europe, banks are working internally on the issue and also with the Loan Market Association (LMA), which published a revised replacement screen rate clause on May 25.

The LMA documentation previously included an interest calculation clause that offered several options if officially published base interest rates – the so-called screen rates – are not available, with lenders’ cost of funds being the last option.

Agents and borrowers can negotiate an alternate base rate, but this requires the consent of all lenders and is considered a short-term solution.

The replacement screen rate clause previously allowed most lenders to accept changes to replace the Libor rate, but this clause would only be triggered if no screen rate was available.

The revised clause is more flexible and allows lenders to set a replacement rate without unanimous consent, and can be triggered even if Libor is still available.

The LMA also addressed the transition period between benchmark rates by including pricing adjustments to narrow the gap between Libor and its successor via amendments and waivers that do not require 100% lender consent.

In the United States, the Alternative Reference Rates Committee’s business lending task force is currently considering alternative wording to Libor that could circumvent the issue of consent, Fitch said.

If the Libor is replaced, the question of who bears the cost of the changes remains unanswered. Borrowers normally pay modification fees, but will be reluctant to pay for modifications that will increase the cost of their loans. (Editing by Tessa Walsh)

Priscilla C. Carnegie