Time Crunch Facing High-yield Loans Without Fallback Language

# Capital Markets

# Risk Management

As Libor cession approaches, borrowers that have yet to seek refis or amendments may face higher execution costs.

Libor will cease to exist on June 30, yet many borrowers in the high-yield loan market have yet to amend or refinance their loans to address the need to switch to a different reference rate.

Syndicated loans with the Alternative Reference Rates Committee’s recommended replacement (or “hardwired fallback”) language will be automatically converted to the Secured Overnight Financing Rate (SOFR) on June 30.

All other legacy loans must be either refinanced into a Libor-replacement reference rate or have their contractual language amended.

Treasury teams at companies with legacy loans must move expeditiously to refinance or amend their language.

Running out of options. A fall 2022 ARRC survey revealed that 51% of lenders prefer that borrowers refinance their loans, and 31% expect to amend the language.

Refinancing, the most efficient option, has been open to investment-grade companies; but the market had been mostly closed to riskier borrowers since last March amid financial market volatility.

“Loan market volatility has eased recently but we have not yet seen a significant uptick in refinancings,” said Meredith Coffey of the Loan Syndications & Trading Association. “That said, we are anecdotally hearing of more fallback amendments.”

Bond and loan analysis firm Covenant Review found that 84% of the 1,416 loans in the Credit Suisse Leveraged Loan Index are still priced over Libor. The index is comprised of the largest and most liquid speculative-grade loans.

“This time last year, I would have guessed 30% or less would still be on Libor,” said Ian Walker, head of middle-market research at Covenant Review.

The most challenging deals. Some leveraged loan borrowers may have to pursue costlier amendments if the high-yield market remains closed to them.

Nearly 10% of loans in the Credit Suisse index do not have any fallback language, according to Covenant Review. Unless these borrowers transition away from Libor before its cessation, the loans will automatically move to the higher prime rate, the fallback stated in most legacy syndicated loans.

The prime rate typically rests at least a couple of percentage points above Libor or SOFR, Mr. Walker said. “That’s the incentive for borrowers to transition.”

Better sooner than later. While 10% may seem small, it means approximately $140 billion of the $1.4 trillion leveraged loan market needs to move to SOFR by June 30—a transition fraught with challenges.

For one, refinancing or amending loans to include a lower rate requires unanimous consent of the lenders.

Loans can also be repriced, a route that allows borrowers to simply replace lenders that do not consent to the repricing. However, repricings are generally sought by borrowers to improve their economics, and lenders are likely to resist.

Whichever method, the path will become more challenging as the deadline approaches and lenders, legal counsel and other involved parties become more swamped with transactions.

Proposed relief. Recognizing the challenge ahead, the Financial Conduct Authority in the UK issued a consultation in November seeking feedback on publishing one-, three- and six-month US Libor on a “synthetic basis” through September 24, 2024.

The consultation period ended earlier this month and the FCA has yet to issue a decision.

An extension would give borrowers breathing room, Mr. Walker said, but if they wait and the proposal fails, then lenders’ position to negotiate terms will be even stronger as the June deadline approaches.

“Borrowers are probably more likely to get the best terms now rather than waiting until there’s a crush and trying to get their deal through,” he said.

Be aware. The Federal Reserve Board adopted a final rule December 16 that implements the Adjustable Interest Rate (Libor) Act passed last spring, replacing certain Libor rates automatically with benchmark rates based on SOFR. However, the Fed rule only applies to Libor transactions with no fallback language, and syndicated loans are typically written to fall back to the prime rate.

“If you’re a NeuGroup borrower, then you may have a mix of loans as well as floating-rate notes or other Libor contracts that have no fallback language,” Mr. Walker said. “So you need to be aware of the Fed rule, since there may be different ways the various instruments transition.”