As you may be aware, there has been discussion in the news about replacing LIBOR in 2021. Please see below for an update on the current situation and our assessment based on conversations with our Agent partners.
Last year the U.K. Financial Conduct Authority announced they will phase out the London Interbank Offered Rate (“LIBOR”) by the end of 2021. Regulators around the globe have been actively working on replacements for LIBOR before the 2021 deadline.
In the U.S., the Secured Overnight Financing Rate (“SOFR”) is being introduced next week by the Federal Reserve Bank of New York in cooperation with the U.S. Treasury Department’s Office of Financial Research. The New York Fed will start publishing SOFR on April 3rd as a reference benchmark.
What is SOFR?
To develop and implement a replacement for the dollar-denominated version of Libor, the Federal Reserve in 2014 set up the Alternative Reference Rates Committee (“ARRC”), which brought together representatives from the private sector and regulators. By May 2016, the committee had narrowed the search to two options: the New York Fed’s overnight bank funding rate, and a rate based on repurchase agreements, which are transactions for overnight loans collateralized by Treasury securities (also known as SOFR or Secured Overnight Financing Rate). After a series of roundtables, and with feedback from advisory groups, the committee identified the latter — SOFR — as the best candidate. Where Libor relied on the expectations of bankers, SOFR is based on real transactions from a swath of firms including broker-dealers, money-market funds, asset managers, insurance companies and pension funds. It’s different from Libor as well in that it’s a secured rate, since the repo rates it’s derived from are collateralized, or backed by assets. It’s an overnight rate, based specifically on overnight loans; Libor, by contrast, covered loan maturities ranging from one day to one year.
What does this mean for my current BancAlliance portfolio?
Each individual credit agreement stipulates what would occur if no LIBOR rate exists. The typical language is that the rate can be determined by the Agent at which deposits in immediately available funds are offered by major financial institutions reasonably satisfactory to the Agent in the London interbank market. There is also often an alternate base rate that is allowed. In most credit agreements, the alternate base rate is the Prime Rate.
What does this mean for Leveraged Loans going forward?
As of now, there is little change in the leveraged loan space. The ARRC has established working groups in order to get credit-based market participants to adopt fallback language in contracts for products such as loans and mortgages in the event LIBOR stops being reported. This is a first step toward the eventual goal of getting firms to make SOFR their benchmark of choice.
What has BancAlliance heard from our Agent partners?
Based on conversations we have had with multiple bank and non-bank agents, the approach is to continue to monitor the situation. Most believe a consensus to emerge around an acceptable alternative industry standard for U.S. middle market lending and will adopt that standard when it becomes necessary to phase out the current LIBOR reference rate. Our Agent partners believe that all existing and future loans will accommodate a move to an alternate rate without issue.
BancAlliance will continue to monitor the situation going forward and will keep you apprised of any major developments.