NEW YORK, March 25 (LPC) - Banks that lend to small to medium-sized businesses are looking to add a baseline to Libor, the benchmark interest rate they make loans against, a move that would ensure the financial institutions a minimum income on the debt securities.
Banks are looking to add so-called Libor floors to their deals involving a revolving credit facility and term loan A, known as a pro-rata tranche, banking sources said.
The floors, which could range from 0% to 1%, would be for loans extended to middle market non-private equity-backed borrowers. A standard floor for deals arranged by non-bank lenders, also known as private credit funds or direct lenders, in transactions for private equity-backed companies is 1%, two bankers said.
Companies pay lenders an interest rate plus Libor, so as Libor falls, companies pay less to borrow. To ensure a minimum return, banks can add a floor that kicks in when Libor drops below that rate.
Libor has swooned and hasn’t fully recovered in recent weeks. On March 2, one-month Libor was at 1.36% and three-month Libor was at 1.25%. On Tuesday, those figures stood at 0.92% and 1.23%, respectively, which were up from lows of 0.61% on March 16 for one-month Libor and 74bp for three-month Libor on March 12.
“A floor is just a tool to avoid the problems raised by negative interest rates,” Walker said. “(Non-bank lenders) are better positioned than (bank) lenders because the market practice for institutional lenders is to have a 1% floor on the benchmark rate.”
The Federal Reserve reduced its target interest rates back down to near-zero, cutting rates consistently in the last year including a half a percentage point cut on March 3 at an emergency meeting. The rate sat at 2.5% in June 2019. Such low interest rates would reduce banks’ income as they receive less for lending. Negative rates, a reality for some time in Europe and Japan, no longer seems an impossibility to some market participants.
“Negative interest rates no longer seem like an impossibility to investors,” said Covenant Review’s Ian Walker, the firm’s head of US middle market lending research. “But negative interest rates raise all kinds of issues, including operational and financial.”
“If Libor really does go that low, that’s just going to be a crushing blow to banks. The view in this environment is banks need to stay open, stay liquid, and make loans,” the second banker said. “Such income could offset revenues lost in other parts of the firm’s business.”
Banks are hesitant to add a Libor floor because no one wants to be seen as taking advantage of borrowers at a moment of uncertainty, and in the face of a potential recession, the third banker said. The middle ground this banker’s firm reached was to ask for a Libor floor if a borrower approached the bank seeking relief of some kind.
Though for syndicated deals, a 1% Libor floor is a necessity, the third banker said.
Private credit, leveraged loan, and high-yield bond markets have all but run dry, leaving banks as one of the few sources of liquidity.
“Every debt market is in price discovery mode,” the second banker said. “When you think about non-investment grade companies, the bank market is the only one that’s open. We’re being forced into thinking about price discovery quicker than other (credit markets).” (Reporting by Andrew Hedlund. Editing by Michelle Sierra and Kristen Haunss.)