There is a real difference between the level of preparedness in the UK/Europe and the UK market, with the transition of USD LIBOR and the other LIBORs running on different timetables. Companies will have to work hard to ensure they avoid falling into synthetic LIBOR.
As the US loan market is much larger than the UK and European markets, it was given more time to transition from LIBOR to SOFR [Secured Overnight Financing Rate]. LIBOR transition for Sterling, Yen and Swiss Francs ran smoothly and many corporates moved their dollar loans to SOFR at the same time as they have moved Sterling to SONIA [Sterling Overnight Index Average], because they just wanted to go through the transition once. But US companies that only operate domestically, and only borrow US dollars, have not been so quick to make the transition.
“The hope was that we wouldn’t have to re-paper all outstanding loans, but transition would be done opportunistically as loans were amended or refinanced,” says Karen Buzard, Partner at Allen and Overy. “Unfortunately, the market shifted so there were fewer incentives to refinance or re-price loans: interest rates went up, and opportunistic refinances and re-pricings have not happened in the way they were in 2021. So loans were not shifted to SOFR in the ordinary course, and we really did not see a move to the new rate until the regulator prohibited new loans based on LIBOR. It was only when those hard rules came into effect, in January 2022, that we started to see significant volumes of new lending based on SOFR.”
While the loan markets are now comfortable using SOFR, Buzard says there is still a backlog of LIBOR transactions that need to transition. “There is far more to be done in terms of transitioning US dollar loans compared to Sterling LIBOR,” she says. “There is a big push now for financial institutions to go out to clients and say, ‘We need to do this, we need to pick up the documents and make the transition, you don’t want to end up in a rate that you didn’t mean to end up in.’ If I was representing a corporate I would 1) make sure that I was operationally ready for SOFR, and 2) check when my USD loan will switch and what it will switch to. Under typical US documents, if LIBOR ceases and no other transition has been agreed, the loan might switch to synthetic LIBOR, which is not intended to be used generally for corporate loans, or switch to base rate that could be a higher rate.”
It does not help that the workload suddenly expanded in 2021, when, for the first time in history, the US leveraged finance market hit over US$3trn. Leveraged loans have grown almost 130% since the financial crisis. Roughly 78%, or US$1.09trn, of US leveraged-loan deals based on dollar volume remained tied to LIBOR as of 12th January, according to Barclays.
There have been reports in the US press that some companies are clashing with their lenders over the amount of interest they will be paying. It has been claimed investors are pushing back, forcing companies to offer them a credit spread adjustment that is usually 10 or more basis points higher.
“Credit spread adjustments for loans converting to SOFR have ranged somewhat,” says Kevin Jones Director of Treasury Advisory at Chatham Financial. “But in most cases, we are seeing companies land somewhere between 10bps and the 11.4bps from the ISDA fallback methodology. This narrow range seems to have evolved to a market norm, so we are not hearing pushback from investors on these levels.”
There will likely be more disagreements over credit spread adjustments as companies stop using LIBOR prior to its end. The ARRC (Alternative Reference Rates Committee) says it wants borrowers and lenders to negotiate sooner rather than later to determine the appropriate spread.
