U.S. Leveraged Loans May Ditch LIBOR Within Weeks

The U.S. leveraged loan market could soon pivot away from the London interbank offered rate (LIBOR) for new deals after officials endorsed a series of forward-looking benchmarks tied to its main U.S. replacement.

The Federal Reserve-backed Alternative Reference Rates Committee’s (ARRC’s) ratification of a term structure for the Secured Overnight Financing Rate (SOFR) should allow bankers and borrowers to begin using the benchmarks as soon as September, according to Meredith Coffey, executive vice president of research and public policy at the Loan Syndications and Trading Association.

The shift would represent a dramatic change for the more than $1 trillion leveraged loan market, which for decades has relied on LIBOR to underpin the risky floating-rate loans that banks make to companies and then divvy up to investors. It’s been among the last markets to make the transition ahead of the yearend deadline to ditch LIBOR for new financings, with industry watchers regularly citing the operational challenges of moving from a forward-looking rate like LIBOR to an overnight rate such as SOFR.

“Both the borrowers and lenders are very interested in having a rate that is known in advance of the interest period,” said Coffey, who noted that the exact timing for when loans will start being benchmarked to SOFR depends on when market participants decide to make the switch.

More than $337 billion of leveraged loans have priced off LIBOR this year alone, excluding repricings, though the vast majority contain so-called fallback language that will see them eventually make the shift to term SOFR as well.

The ARRC ratified term rates for one-, three-, and six-month tenors based on the CME Group Inc.’s SOFR futures.

“With this step, market participants now have every tool they need to transition from LIBOR,” said Randal Quarles, vice chair for supervision of the Federal Reserve Board and chair of the Financial Stability Board (FSB), in a press statement. “All firms should be moving quickly to meet our supervisory guidance advising them to end new use of LIBOR this year.”

The recommendation comes after the completion of a key change in interdealer trading conventions on July 26, the first phase under the ‘SOFR First’ initiative. Because SOFR is a risk-free rate that tends to trade below LIBOR, investors may demand that new loans using the benchmark come with a higher margin, market watchers say.

Term SOFR could also open the door for the rest of the syndicated corporate loan market to adopt the new rate, namely revolving credit facilities—loans provided by a group of banks to a company. These are structurally different from traditional loans because so-called revolvers can be borrowed and paid back repeatedly over a period of time.

So far, only Ford Motor Co. has announced its intention to refinance its revolving credit facilities with SOFR.

The endorsement of SOFR term rates could also encourage new CLOs—which package and sell leveraged loans into chunks of varying risk and return—to use the new reference rate if the loans they purchase also use term SOFR, said Coffey, who is also a member of the ARRC.

CLOs will face a period of time where they could be issued with one rate but own leveraged loans that use multiple rates including LIBOR, SOFR, and other alternatives. The CLO equity holders are ultimately expected to absorb this basis risk, which is conceptually similar to existing mismatches between LIBOR tenors being used, Coffey said.

The United States

Apple Inc. is among the series of companies that tapped the investment-grade market on Thursday.

• Blackstone Group Inc. teamed up with other lenders to provide $2.15 billion of financing directly to Cambium Learning Group Inc., bypassing banks in one of the biggest such loans that investors have made.
• The riskiest slice of the high-yield market, the CCC tier, is on track to post its first monthly loss since March of 2020. A decline would snap a 15-month positive streak that’s the longest run of gains since 1992.
• In high yield, liquefied natural gas provider Venture Global Calcasieu Pass LLC sold $2.5 billion of notes in two parts, upsized from $1.5 billion.

Europe

Just one high-yield deal was sold on Thursday as the market enters a summer slowdown.

• Software developer PeopleCert Wisdom Limited sold a 300-million euro (US $356 million) bond.
• Credit Suisse was the latest European bank to post earnings; the lender reported Q2/2021 profit that missed analyst estimates, adding to CEO Thomas Gottstein’s challenges after the Archegos Capital Management and Greensill scandals hit the bank’s reputation.
• Franklin Templeton, which oversees $1.5 trillion in assets, is betting that European Central Bank (ECB) policymakers won’t exclude companies that are still transitioning to more sustainable models.

Asia

Yield premiums on Asia dollar bonds dropped sharply Thursday, but that wasn’t enough to spur borrowers to return to the region’s primary debt market.

• Spreads tightened after China made efforts to soothe market nerves and the Federal Reserve gave reassurance that it’s moving very gradually toward tapering stimulus.
• There was no major new offering in the U.S. currency in the region for a third straight day, even as financial markets rebound from a selloff earlier in the week that was sparked by Beijing’s crackdown on private enterprises.
• Investors should consider “gradually and selectively” buying Chinese high-yield dollar bonds after a recent selloff opened up an unsustainable gap with the latter’s Asian peers, according to Owen Gallimore, head of trading strategy at Australia & New Zealand Banking Group.

—With assistance from Alexandra Harris.

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