LONDON, July 27 (LPC) - A staggering US$4trn of outstanding syndicated loans may have to be repriced if Libor is discontinued, because replacement rates could be substantially lower than the existing benchmark.
Libor provides an interest rate benchmark for nearly all syndicated loans, FRNs and derivative products, as well as intercompany loans and other types of commercial contracts.
Its replacement will affect every loan contract and make it more difficult for treasurers to calculate their borrowing costs.
“This is a serious cashflow management issue for corporates,” a loan syndicator said.
Since banks were found to be fiddling Libor submissions before, during and after the financial crisis, regulators have been pushing to replace Libor with substitute rates that are based on actual transactions and less open to market abuses.
They have set a deadline of the end of 2021 to find a suitable replacement for Libor.
Libor is likely to be replaced with risk-free rates such as the Secured Overnight Funding Rate for US dollar loans and the unsecured Sterling Overnight Index Average for sterling loans.
Libor is a forward-looking term rate based on one, three, six and 12-month contracts. It provides certainty of funding costs because the interest payable and tenor is known in advance, and also offers lenders premiums for longer-dated maturities.
At the moment, the new RFRs are backward-looking overnight rates, which do not take banks’ cost of funds or credit risk into account. They also do not compensate lenders for the length of the contract and are priced lower than Libor. MIND THE GAP The gap between the rates and the lack of detail will make it harder for company treasurers to predict the cost of their debt and match funding, bankers said.
“It’s certainly not ideal. Both lenders and borrowers need to know how much will be paid on a loan. It’s important for cashflow management,” a senior banker said.
Based on historical data calculated by the Federal Reserve Bank of New York and cited in a report from Fitch Ratings, SOFR could be as much as 75bps below Libor, which would require loan pricing to be hiked to maintain the original return on a loan.
Borrowers and lenders have already been amending existing credit documents to include Libor replacement language before the 2021 deadline.
Although the amendments give a mechanism for establishing new base rates, they do not effectively address the revisions to the credit margins that will be required, Fitch said. COMPLICATED The Libor replacement process is complicated by the fact that credit agreements and lenders have different levels of consent rights which need to be agreed when agent banks and borrowers agree a revised base rate.
Lenders often have negative consent rights on revised base rates and are seen to have agreed to the new rate if they do not object within a limited timeframe. Lenders also sometimes have additional consultation rights.
In a rising interest rate environment, some banks could try to use their consent rights to reprice loans at even higher levels, which could leave lenders lacking consent rights at a distinct disadvantage in negotiations, Fitch said. WORK IN PROGRESS In Europe, banks are working internally on the issue and also with the Loan Market Association (LMA), which published a revised replacement screen rate clause on May 25.
LMA documentation previously included a calculation of interest clause that gave several options if officially published base interest rates - so-called screen rates - are not available, with lenders’ cost of funds as the last option.
Agents and borrowers can negotiate an alternative base rate, but that requires all-lender consent and is seen as a short-term solution.
The replacement screen rate clause previously allowed most lenders to agree amendments to replace the Libor rate, but that clause would only be triggered if no screen rates were available.
The revised clause is more flexible and allows lenders to put a replacement rate in place without unanimous consent, and can be triggered even if Libor is still available.
The LMA also tackled the transition period between reference rates by including pricing adjustments to reduce the gap between Libor and its successor via amendments and waivers that do not need 100% lender consent.
In the US, the Business Loans Working Group of the Alternative Reference Rates Committee is currently considering Libor replacement language that could bypass the consent issue, Fitch said.
If Libor is replaced, the question of who bears the cost of the amendments remains unanswered. Borrowers normally pay amendment costs, but will be reluctant to pay for changes that will increase the cost of their loans. (Editing by Tessa Walsh)