NEW YORK, April 12 (Reuters) - Staffing company On Assignment is one of many US borrowers that have taken the opportunity of a leveraged loan refinancing to remove an unwanted ‘Libor floor,’ which artificially increases their borrowing costs.
Leveraged loans typically pay an interest margin plus Libor, but Libor floors were added during the financial crisis to guarantee minimum yields for investors after Libor rates plummeted.
Robust loan market conditions and higher Libor rates since the start of 2016 mean that Libor floors are no longer required. Companies are choosing to remove them or set the rate at zero while investor demand for floating-rate loans remains strong in a rising interest rate environment.
In the first quarter, 24% of companies either issued loans without Libor floors or set the rate at 0%, compared to only 10% a year earlier, according to LPC data.
“Libor floors made their way into the market during the last down cycle in order to entice investors to buy leverage loans,” said Enam Hoque, a senior covenant officer at Moody’s Investors Service. “There’s really no need to entice investors any longer.”
On Assignment was able to remove a 75bp Libor floor when it refinanced an existing loan in February and cut 50bp off its interest margin to 225bp over Libor, according to Thomson Reuters LPC data.
“Any time you can do a repricing, you’d like to get the most beneficial terms you can and so to the extent the market allows you to remove the Libor floor, you want to remove the Libor floor,” said Jim Brill, treasurer and chief administrative officer at Calabasas, California-based On Assignment.
The company also refinanced in August 2016, but was unable to remove the 75bp Libor floor. One-month Libor on September 1 was 52bp, which meant that the company had to pay around 23bp more to meet the Libor floor rate.
During the credit crisis, three-month Libor slumped by 94% to 28bp in October 2009 from 482bp in October 2008 after Lehman Brothers filed for bankruptcy.
Since the start of 2016 the rate has risen 89% to 1.16% on April 11, initially in response to pending money-market reform and then in concert with interest rate hikes. Three-month Libor topped 1% in January 2017 for the first time since May 2009 and now exceeds the most common Libor floors of 75bp or 100bp.
The Federal Reserve increased its target interest rate in March by 25bp to 75-100bp and said it expects two further hikes this year and three in 2018. Unlike bond investors, loan investors receive higher yields when rates rise.
Investors have poured more than US$13.65bn into bank loan mutual funds and exchange-traded funds this year as of April 5, far exceeding flows of US$8.6bn in 2016, as investors try to hedge against rising interest rates.
Increasing investor demand allowed borrowers to refinance a record US$261.2bn of loans in the first quarter, according to LPC data. The average yield on a B rated loan was 5.02% in the first three months of the year, down from 6.99% in the first quarter of 2016.
“Loan pricing is already low, and covenant-lite and otherwise weak covenant structures dominate the market, so borrowers in 2017 are clearly targeting the Libor floor as an additional concession,” said Hoque. (Reporting by Kristen Haunss; Editing By Tessa Walsh and Jon Methven)