Report: Loan issuer breaks ice on SOFR as Libor fallback

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Covenant Review says a private issuer has gone to market with what is believed to be the first syndicated-loan deal that proposes to adopt the Federal Reserve’s recommended Secured Overnight Funding Rate benchmark in the event of the demise of Libor.

The credit research firm's report said the unnamed issuer wants to amend contract language for an existing term/revolving facility permitting the offered securities to be priced to a forward-looking SOFR rate in place of Libor should the publication of the London interbank lending rate cease after 2021. (Such a SOFR term rate has yet to be determined by the Fed's Alternative Reference Rates Committee, or ARRC, but one is expected prior to 2021.)

The issuer is an industrial borrower in a loan syndication being arranged by Morgan Stanley. Covenant Review did not disclose the name of the company, due to the private arrangement of the credit agreement.

Covenant Review believes it is the first time an issuer has marketed a deal looking to adopt the SOFR term rate as a fallback, and could be the start of “widespread adoption of the ARRC’s recommendations in the near-term,” the report stated.

“[W]e expect to see an uptick in deals that adopt a version of the ARRC’s final recommendations for syndicated loans,” the Covenant Review report stated. “The ARRC’s recommendations are robust and include significant protections for all parties.”

Covenant Review noted in April that JPMorgan Chase was the first to adopt ARRC recommendations for Libor fallback language in a floating-rate bond offering.

Widespread adoption in loans and securitizations has had doubters, given the slow pace of scattershot plans that issuers, borrowers and banks have put into place for replacing Libor – if any.

The ARRC recommendations on fallback language for Libor transition were finalized in April for syndicated loans and high yield bonds. Covenant Review’s report on Friday was issued the same day ARRC finalized similar recommendations on how agent banks and lenders should cope with Libor cessation in bilateral bank loans and securitizations.

Friday’s ARRC announcement itself preceded comments Monday by Federal Reserve Vice Chairman for Supervision Randal Quarles for banks to simply “stop using Libor” due to the near certainty of its short-term demise.

After 2021, U.K. regulatory authorities will no longer require panel banks to extend the daily quotes used to derive Libor rates across five currencies and seven tenors, resulting in uncertainty of whether Libor rates will continue to be published and administered.

Daily Libor rates have been issued since 2014 by the Intercontinental Exchange (ICE) Benchmark Administration, an organization that has pledged to continue reporting Libor rates after 2021.

The ARRC recommendations on securitizations were published Friday after the working committee (which includes members of the Loan Syndications & Trading Association) mulled over nearly 50 comments that it received on its earlier proposal. The rate adoption methods were endorsed by a consensus of its business loans and securitizations working groups, the ARRC stated.

The Fed recommends that issuers shift their products to SOFR from U.S. dollar Libor rates whenever possible, “but those that continue to use Libor need to make sure they have very strong fallbacks in place,” said ARRC committee chairman Tom Wipf, according to the release. Wipf is vice chairman of institutional securities at Morgan Stanley.

The recommended language would not only include the use of a forward-looking SOFR rate to be determined, but also outlines “hardwired” transitional triggers on when the rate would be adopted as well as how issuers would apply spread adjustments to protect investors from potential losses with a new spread.

The final recommendations were similar to the ARRC’s proposed transitional mapping procedures in December, as well as its final recommendations in April on fallback contract language for syndicated loans and floating-rate notes.

The ARRC’s recommendations include benchmark transition language that would account for when to stop using Libor, and a decision tree on a new benchmark rate to adopt.

The trigger events could be an actual cessation of the Libor rate – such as an announcement from the benchmark administrator that rates will no longer be published – or if the “pre-cessation” triggers that would show Libor is no longer “representative” of the market.

That is a decision the ARRC envisions for placement agents and banks to determine. (Covenant Review noted that the private issuer loan amendment in its report is an amendment proposal that includes the borrower’s consent.)

The trigger events for Libor cessation include the departure of one or more panel banks from a voluntary Libor reporting regime, or if a majority of underlying assets in a securitization deal (such as loans) are no longer based on Libor.

ARRC’s recommendations also include a multi-step replacement rate determination, led by its term SOFR rate with the proper spread adjustment that has been approved by the Federal Reserve Board, the New York Fed or a Fed committee designated with the power to determine the SOFR term rates (such as a one-month or three-month rate).

If such a rate has not been enacted or approved by the time the Libor rate is dead, the ARRC’s recommendation would be the use of a SOFR rate derived from compounded daily overnight rates, or a simple average of those daily rates, over a relevant period of one, three, six or more months.

The ARRC’s recommendations on rates include a possible version from the International Swaps and Derivatives Association, which is developing a methodology to add that credit-risk premium to a SOFR-derived rate.

SOFR is based on the nearly $800 billion in daily clearing activity in the overnight Treasury repurchase agreement market. It has been used as the reference rate on $80 billion in securities since its launch last year, including four Fannie Mae securitizations totaling $15.5 billion. But as a risk-free rate that applies to overnight transactions, critics contend the rate as-is more suitable to derivatives than corporate loans and syndications.

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