Sixty-Day Countdown to LIBOR Cessation

June 30, 2023, marks the planned cessation date for U.S. dollar LIBOR. Our experience from the cessation of Sterling LIBOR and the current state of discussion with clients indicates that a large push for conversions to alternative reference rates (ARRs) will spike in May 2023.

In practice, that impending sixty-day countdown means we are moving into an intensive period of decision-making, negotiation, and amendments to documentation. We have taken a step back to consider everything that needs to happen between now and LIBOR’s end date.

Loan agents will play a key role in facilitating these conversions, including the distribution of notices and system changes to accommodate new rates. At Wilmington Trust, we have been preparing for this surge for quite some time. More generally, lenders should expect their agents to make similar efforts to facilitate ARR conversions on the deals they service.

But agent readiness is only one piece of the challenge. Preparedness for transition also requires collaboration among stakeholders. In the coming sixty-day countdown, changes to terms and documentation will affect all participants in complex deals, including arrangers, participating lenders, borrowers, and the various service providers supporting them.

Additionally, loan stakeholders have to manage an entirely new set of concerns in the current financial climate: rising interest rates, greater volatility in spreads, and worries about banking stability—it is unlikely that regulators imagined that the cessation date would fall in the midst of so much turbulence. With time and attention stretched thin, many do not have a lot of room on their plates to deal with the waterfall of activities needed to replace rates in each relevant deal.

Wilmington Trust made a conscious decision to be vocal in encouraging clients to take steps sooner rather than later. We have seen well over a third of the deals we service transition. Still more have begun the process. These figures trend higher than the industry as a whole.

As of February 2023, 17% of CLO floating rate liabilities and 26% of the JPM Loan Index referenced SOFR, according to data cited by the LSTA.¹ The LSTA further reports that more than $60 billion of leveraged loans switched to SOFR in January 2023. Although this activity signals gathering momentum, it represents only a tiny percentage of loans still using LIBOR.

As a forward-looking rate that incorporates reporting banks’ calculations of risk, LIBOR is naturally higher than SOFR. To minimize the disadvantage to lenders, the Alternative Reference Rates Committee (ARRC) has established fixed Credit Spread Adjustments (CSAs) of 11, 26, and 43 basis points for 1-month, 3-month, and 6-month LIBOR. However, the actual spreads may be higher, which creates an opening for negotiation.

Some loan contracts specify a hard-wired fallback to ARRC rates. In other words, if the lender does nothing, the rate will become SOFR plus the additional spread. But there is a natural tension in the market, with borrowers seeing an opportunity to push lower to manage their interest costs and lenders (i.e., arrangers and syndicate lenders as well as holders of CLOs) eager to prevent any decrease in returns caused by unnecessarily lower rates.

The difference between various forms of SOFR also plays a part. Loan industry participants have increasingly favored “Term SOFR,” a forward-looking measurement of SOFR rates administered by CME and endorsed by the ARRC. Other forms of SOFR are retroactive (i.e., Compound SOFR in Arrears) and may be compounded or averaged using various intervals (30, 90, or 180 days).

Parties to a loan whose documentation does not include a hard-wired fallback may struggle between the difference between forward- and backward-looking implementations of SOFR. Forward-looking rates advantage lenders in a rising rates environment; they are favorable for borrowers in a decreasing rates environment. These considerations would have been moot in the flat-rate environment between March 2020 and March 2022.

In the face of room to maneuver on rates, some lenders may prefer to wait and see what the interest rate and broader macro environment look like in May 2023. Others may be hoping for a synthetic LIBOR calculated by the Financial Conduct Authority (FCA) to provide a lifeline at the last minute if enough open LIBOR contracts remain.

However, synthetic LIBOR will not be a representative rate. Since most contracts require using a rate that is representative, the synthetic rate would only be useful for contracts that do not include representative rate language. Such contracts would generally be among the oldest contracts prior to a time when LIBOR cessation plans emerged. Moreover, betting on procrastination comes with some risks. 

For LSTA-compliant loans, lenders would fall back to term SOFR, potentially pushing their rates lower than a negotiation might have allowed. Borrowers might also feel this pain once rate increases begin to reverse. However, the impact on agents would be neutral once the rate change takes effect.

For LMA-compliant loans, contracts would fall back to the cost of funds, potentially even per lender. This scenario would create administrative complexity for agents, especially in facilities with many lenders. In addition, lenders could see costs of funds at lower rates than LIBOR, and borrowers would lose the protection of a stable and objectively determined rate.

In either scenario, the resulting mismatches have implications beyond the negotiation and amendment process. They also add new wrinkles for asset and liability management. Specifically, it creates a new and different calculus around interest rate risks and asset coverage ratios.

While third-party agents cannot and should not play a discretionary role, it is imperative for them to commit operational and technical resources to the transition of each lending facility they service. These resources should already be in place by now, ready to act on the terms of the agreement between lenders and borrowers.

In addition, agents should already be in dialogue with their clients for all remaining LIBOR-pegged loans. Conversation helps agents prepare for the eventual transition. It benefits lenders, too, by clarifying the operational implications not only for individual transactions but also for anticipating the volume of amendments and waivers and for examining the impact for lenders across their entire book of loans.

As U.S. LIBOR loans approach the sixty-day countdown of transitional activities, our Loan Market Solutions team is happy to answer questions and share insights. We invite you to get in touch.

ARRC: Alternative Reference Rates Committee

ARRs:  Alternative Reference Rates

CLO: Collateralized Loan Obligation

CSA: Credit Spread Adjustment

LIBOR: London Interbank Offered Rate

LMA: Loan Market Association

LSTA: Loan Syndications and Trading Association

SOFR: Secured Overnight Financing Rate

If you have questions, contact your Wilmington Trust Relationship Manager or visit our Global Capital Markets LIBOR Transition resource page for more information.