August 10, 2017 / 5:20 PM / 2 years ago

LPC: CLO market makes room for Libor alternative

NEW YORK, Aug 10 (Reuters) - US Collateralized Loan Obligation (CLO) funds are reworking their documentation to accommodate new benchmark rates following news that the London Interbank Offered Rate (Libor), which is used to set rates on loans from corporate borrowings to mortgage payments, will be replaced.

Some CLO documents have already been updated to allow for the change, after the head of Britain’s financial markets regulator said on July 27 that a substitute must be in place by the end of 2021.

Libor is being retired after bankers were found guilty of manipulating the key benchmark interbank borrowing rate in one of the banking industry’s biggest scandals.

Switching to an alternative rate will bring changes to trillions of dollars of investments. The US$928bn US loan market and the US$459bn US CLO market both rely on Libor to set interest payments.

“It’s a big change because all of the loans we cover, from US$50m to multibillion dollar loans have Libor as an interest rate,” said Ian Walker, an analyst at credit research firm Covenant Review. “It’s definitely a big deal.”

Three-month Libor, one of the most common leveraged loan benchmarks, has risen 114% to 131bp on August 10 from the start of 2016, increasing the cost borrowers must pay lenders. It had been stuck below 25bp from the end of 2013 until the start of 2015.

Last month Andrew Bailey, chief executive officer of the UK’s Financial Conduct Authority, said that Libor must be replaced by 2021 due to insufficient transactions underpinning the rates. He said the work to shift to an alternative must “begin in earnest.”

After his comments, several CLOs that were being marketed were reviewed and their documents were changed to allow an alternative rate to be used when Libor is retired, sources said. The provisions are varied, but many require a majority of one or more classes of investors to approve the change.

“Whatever a manager can do to minimize the holdup [for a benchmark change] is preferred,” said Seth Katzenstein, a portfolio manager at Intermediate Capital Group (ICG). “Investors also want to make sure the transaction operates smoothly and if Libor goes away and loans are using some other market-based mechanism, [the CLO market] would want to move the liabilities in the structure to that same mechanism.”

ICG priced a US$503.4m CLO with Citigroup on July 31, only four days after Bailey’s speech. A provision was added to the deal that allows for an alternative rate as long as holders of the controlling class confirm the change and rating agencies confirm that it will not affect existing ratings, the sources said.

Katzenstein declined to comment on the CLO.

Investment firm CBAM Partners included language in its US$1.6bn CBAM 2017-2 CLO, which also priced on July 31, that lays out steps to be taken to use a different benchmark in the future, sources said.

A CBAM representative declined to comment.


Investors have also been looking at the impact that a Libor alternative would have on leveraged loans.

The Loan Syndications and Trading Association (LSTA) does not need to change its existing model credit agreement as it does not define Libor, according to Bridget Marsh, deputy general counsel for the LSTA who leads the organization’s document development and standardization efforts.

The trade group is working on a draft of a new model revolving credit agreement, which it is planning to release for comments from members in September, and may consider including a provision in that document that would allow for a Libor replacement.

In 2014 the Loan Market Association (LMA), a European loan trade group, released an optional credit agreement provision that allows for an alternative benchmark if Libor is no longer available as long as the borrower and a majority of lenders agree to the replacement, according to Nicholas Voisey, a managing director at the LMA in London.

The Asia Pacific Loan Market Association (APLMA) also includes an option for a replacement benchmark in its current documentation that requires approval from the borrower and a majority of lenders, according to the trade group’s August 8 weekly update.

Without a current alternative, market participants are being careful about document changes to avoid ambiguous language in credit agreements.

“Borrowers don’t want to say that lenders can determine the rate and lenders aren’t going to say that borrowers should be able to select it, so we’re waiting to see what the market lands on,” said Judah Frogel, a partner at law firm Allen & Overy. (Reporting by Kristen Haunss; Editing by Tessa Walsh and Michelle Sierra)

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