US loan market begins to pull away from tarnished Libor benchmark
Firms borrowing in the U.S. lending market are finally pulling away from Libor, just months before the scandal-stricken benchmark that underlies trillions of dollars in financial instruments was cut. no longer available for new transactions.
A handful of companies have now borrowed money using the widely accepted replacement for Libor called Sofr, according to data from Refinitiv and LCD. Others are in the market with new offers.
The adoption of the Sofr – calculated on the basis of market transactions – marks an important step in setting a new standard after Libor’s reputation was irrevocably damaged a decade ago when bankers manipulated the key interest rate. Regulators have demanded that no new deals be tied to Libor from 2022, phasing out the benchmark by the end of June 2023.
“You can’t continue writing Libor loans until December,” said Brian Grabenstein, head of the Libor transition office at Wells Fargo. “If we have to stop on December 31, it cannot continue as usual until then. ”
The Libor has for many years acted as a benchmark on which everything is based, from mortgages to credit cards and interest rates to business loans, so the outcome of the benchmark reform process will have implications. large scope.
Bankers said the transition in the lending market has been slow, in part because there is no benefit for companies to be the first to move away from Libor. Negotiations are still underway to determine new tariff agreements linked to Sofr.
The slow adoption of a so-called Sofr forward rate, which allows companies to plan for future interest rate payments by giving a forward-looking estimate of where the Sofr will be located, has also held back progress, said. said the bankers. Nevertheless, it is increasingly urgent to accelerate the adoption of Sofr before the abrupt end of the year.
Bank of America brought in the first Sofr syndicated loan transaction in September for poultry producer Sanderson Farms, securing the deal at Libor but with an automatic switch to Sofr at the end of the year.
JPMorgan, another major US bank, then brought the first Sofr-listed transaction when it was issued in October, for commercial real estate finance company Walker & Dunlop.
Onex Credit Partners, which operates loan packages that secure payments on new debt tranches called secured loan bonds, brought the first Sofr-linked CLO deal to market last week.
One area that has complicated the process is how to account for the fact that the Libor interest rate is higher than that of the Sofr. This means that the interest rate on the transactions must be adjusted so that the borrowing costs end up being equal when the transactions are entered into with the new benchmark.
The Alternative Reference Rates Committee, a sector body created by the Federal Reserve, recommended adjustments of around 0.11, 0.26, and 0.43 percentage points for the respective one-month, three-month, and six months.
However, some investors say businesses and bankers are taking advantage of strong demand for new loans to lock in small adjustments.
This situation played out in the Walker & Dunlop deal when investors initially balked at a 0.1% adjustment as insufficient, according to people familiar with the matter. JPMorgan finally struck a deal to appease the lenders.
“It’s a very hot market,” said Steve Hasnain, portfolio manager at PineBridge. “It’s a borrowers market. Lenders are not able to push back as much. I would say that because of the market we are in there is some transfer of value from lenders to borrowers.
Nonetheless, bankers and investors expect the pace of adoption to continue to pick up before the end of the year. All new loan financings, such as mergers and acquisitions that JPMorgan underwrites, are tied to Sofr if they are to be assessed next year, said Kevin Foley, the bank’s global head of capital markets.
Grabenstein added that Wells Fargo has not “put a complete end to the Libor loans, but we go to the customer first with Sofr and only if there is a real need to use the Libor if this is still being considered. “.
Last month, the ARRC warned market participants to leave their Libor transition until the last minute. “You wouldn’t wait for the moving truck to arrive to pack the china; you have to package and label everything carefully beforehand, ”said Tom Wipf, president and vice president of institutional securities for the ARRC at Morgan Stanley.
Libor vs. Sofr
Libor stands for London Interbank Offered Rate and has been one of the most important interest rates in global finance since the 1970s. Originally intended as an estimate of unsecured bank financing costs to support bank-to-bank transactions , its usefulness declined as lenders began to demand more and more collateral to negotiate with each other. Based on submissions from a panel of leading lenders, his reputation was tarnished when it was discovered that bankers had rigged the rate, leading to numerous calls for his replacement.
Sofr is the guaranteed overnight funding rate, which differs from Libor because it is based on actual transactions in the repo market, where cash is borrowed against assets such as treasury bills. The Alternative Reference Rates Committee, a sector body set up by the Federal Reserve, chose Sofr as its preferred replacement for Libor in 2017, but market adoption was slow before the year-end deadline to stop entering into new Libor related contracts.