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Capital Markets

Contract Language for Libor End Falls Short

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July 25, 2018

Fitch says current language in contracts related to syndicated loans is inadequate and could lead to repricing

BankingDespite overall inertia about moving away from the London Interbank Offered Rate, there have been a few proactive organizations who are at least looking to amend the language in the documentation. The problem is, just changing the language may not be enough, according to Fitch Ratings. And unless it’s revised again, some $4 trillion in syndicated loans could be repriced. If this happens, it may have an impact on ratings, Fitch said in a research document.

“Borrowers and lenders of syndicated loans have been amending their credit documents to include LIBOR replacement language as a result of the rate's anticipated 2021 phase-out,” Fitch said. However, “we believe the replacement language does not effectively address necessary revisions to credit margins despite providing mechanisms to establish a new base rate in place of LIBOR.”

Libor, as most everyone involved now knows, is set to sunset by 2021. That’s when banks will be encouraged not to use the reference. The problem is Libor is deeply entrenched, both in institutional and retail loans. In addition to syndicated loans outstanding, there are also $170 trillion of swap contracts still tied to Libor rate. Then there are mortgage-backed securities that involve quite a few more trillions. 

In the case of syndicated loans, Fitch explains that there are degrees of difference when it comes to credit agreement consent rights that lenders have “once the administrative agent and the borrower agree on a revised base rate.”

“Required lenders are often provided negative consent rights to the renegotiated base rate. In such a case, they are given a limited time frame in which they may object to the new rate. If no objection is lodged, the lenders are deemed to have consented to the new rate. Sometimes, required lenders may have additional consultation rights and may be party to the renegotiation itself. However, in the case of The Stars Group (B+/Stable), the administrative agent and the borrower retain the sole right to negotiate a LIBOR replacement and required lenders cannot object to the renegotiated base rate.”

Fitch says that any resultant repricing "may ... affect a company's cost of debt, which may ultimately implicate credit quality if altered significantly." 

And LIBOR replacements may only exacerbate the situation. For instance, the New York Federal Reserve’s Secured Overnight Financing Rate (SOFR) is one reference rate likely to replace Libor in credit agreements. But Fitch noted that based on historical data calculated by the Fed, SOFR could run as much as 75 basis points below Libor “due to its secured nature and would necessitate a corresponding hike in credit margins if the originally negotiated pricing on the loan were to be preserved.

“Indeed, any alternative base rate would compel some revision to the credit margin in order to mirror the Libor-based price of the loan,” Fitch said.

Meanwhile, the Federal Reserve could be working on a solution. There is a meeting scheduled for July 26 at the New York Fed that will focus on preparing for a world without Libor, which will include a panel discussion that will address crucial details like ideas for language to be used to replace Libor in contracts for financial products like business loans, derivatives and floating-rate notes.

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