This Wall Street Journal article highlights the reluctance of many companies to replace the London Interbank Offered Rate (LIBOR), a global benchmarking vehicle for lending deals, which is being eliminated with an effective date of January 1, 2022. This phase out of LIBOR has been known for about four years, and we wrote about the issue and reasons in member research back in 2019. LIBOR is calculated daily by a panel of banks and used as a basis for bank borrowing as well as a benchmark for calculating rates in other loans and derivatives contracts across the globe. It functions as a global equivalent to the Fed Funds rate in the U.S. As a result of LIBOR rate manipulations that came to light in 2012, U.K. regulators decided to phase out LIBOR by 2021. At the time, the Fed had estimated that at least $35 trillion of LIBOR-based contract value would not have expired by the end of 2021. Some companies continue to use LIBOR.
‘Libor, which dates back to 1986, remains attractive to companies for a variety of reasons, such as favorable rates and familiarity with its behavior, according to executives, lawyers and advisers. Executives have gotten comfortable with using Libor, they said… Low interest rates and strong investor demand for higher fixed-income yields have spurred record sales of riskier corporate debt tied to Libor such as leveraged loans, which private-equity firms use to finance corporate buyouts.
Total leveraged-loan sales have already set a yearly record in 2021 at over $585 billion through November, up from $288 billion during the prior-year period, according to S&P Global Market Intelligence’s LCD, a data provider… Chicago-based TransUnion used Libor for two leveraged loans totaling $3.74 billion to help finance the acquisitions of information-services company Neustar Inc. and digital-identity-protection company Sontiq, both of which closed Dec. 1. A $3.1 billion loan will expire in 2028, while a $640 million loan carries an eight-year term, TransUnion said. That means the company will have to make changes to the rate quoted in its loans once the June 2023 deadline approaches…
Many companies plan to switch to the Secured Overnight Financing Rate, or SOFR, the preferred Libor replacement of U.S. regulators and Wall Street, analysts and executives said. Others are weighing credit-sensitive options such as the Bloomberg Short Term Bank Yield Index and Ameribor, which reflect lenders’ funding costs and bear a similarity to Libor.’
Although it would seem a manageable task, the effort is more complicated than most understand, as these rate benchmarks are embedded in company systems, processes, and models (among other things). A major replacement transition can touch on multiple business groups, such as banking, capital markets, insurance, and asset management, and get further dispersed across different subsidiaries, branches, and countries. Therefore, transitioning from LIBOR to a new reference rate requires identifying exposure and fallback language across many businesses and agreements. As readers may expect, there are implications for accounting and balance sheet management that could cause bank business disruption, so this procrastination is somewhat understandable. However, we also have to believe that most if not all of the work has been done, and the transition is more about training going forward.
‘Many U.S. companies have been sluggish to transition away from Libor. Around $10 billion worth of junk-rated corporate loans sold this year through November have been tied to SOFR, according to LCD—or just 1.7% of this year’s total sales of $595 billion… Walker & Dunlop Inc. was the first U.S. company to issue a leveraged loan tied to SOFR this year. The commercial real-estate financing provider in October closed on a $600 million loan due 2028 to finance the acquisition of Alliant Capital, a tax-services provider, which is expected to close before the end of this quarter… The loan pays investors an extra yield, or spread, of 2.25% over SOFR, plus an adjustment of 0.1% to 0.25% based on the monthly term.
Mitchell Resnick, the company’s senior vice president and treasurer said creditors had different viewpoints about the so-called credit adjustment rate. “That was the most interesting part. It was good to have engaging conversations with lenders and eventually come to an agreement,” he said… The transition from Libor to SOFR was an easy one for the Bethesda, Md.-based company, Mr. Resnick said, because finance workers were familiar with the new reference rate due to the mortgage business. Government-controlled mortgage companies Fannie Mae and Freddie Mac switched from Libor to SOFR in 2020… “SOFR is not something [that is] unusual to us. It seemed like a logical transition,” Mr. Resnick said. “If you have to explain to folks internally what SOFR stands for and how to look it up, you will get a lot more hesitancy around it.”’
Overview by Steve Murphy, Director, Commercial and Enterprise Payments Advisory Service at Mercator Advisory Group
