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LPC: U.S. banks grapple with negative Libor

NEW YORK (Reuters) - Lenders are guarding against low interest rates in the US and negative rates in Europe and Asia by introducing zero Libor limits to investment-grade loans for their clients.

The logo of Dow Jones Industrial Average stock market index listed company Boeing (BA) is seen in Los Angeles, California, United States, April 22, 2016. When aircraft manufacturer Boeing entered into US$5bn in credit facilities late last year, the credit agreements included Zero Libor language. REUTERS/Lucy Nicholson

With three-month Libor at around 63bp and the forward Libor curve trending upwards, a negative US Dollar Libor rate is unlikely at this point. However, given the precedent of negative interest rates in other regions, bankers remain concerned that the rate at which banks lend to each other in US dollars could turn negative, eroding margins and, in a remote scenario, costing them money to lend.

“An increasing number of banks have put it on their list of terms to put in every deal,” said Adam Wolk, a partner with Mayer Brown. “Now it’s rare to see a deal get signed up without a Libor floor.”

Revolving credit facilities provide investment-grade borrowers with quick access to credit to back commercial paper programs and other general corporate purposes. In most cases they remain undrawn, and for that reason, the companies pay their banks a small fee.

When revolving loans are drawn down, however, borrowers pay interest at Libor plus a margin. A negative rate could eat into the margin. In an extreme case it could, theoretically, fully erode the margin, bankers suggest.

NOT LESS THAN ZERO

Zero Libor floors protect the margin from being eroded by negative Libor rates and against the remote possibility of lenders paying to park their money with a borrower.

While there is no language in credit agreements to provide for lenders paying borrowers, by including a zero limit on Libor, it ensures it cannot happen.

“The forward curve says [Libor] is going to go up, but there’s always a probability game, there’s always a theoretical chance that the world ends and it goes down,” said a banker.

To stimulate economic recovery, central bank activity has resulted in negative Euribor rates and Japanese Yen Libor, raising worries about the potential effect on lending to investment-grade credits in the US.

Zero Libor floors first started appearing in loans when Swiss Franc Libor turned negative in December 2014. In January 2015, the three-month Swiss Franc reached a low of negative 74bp. Though US Libor is unlikely to turn negative at this point, bankers are encouraging borrowers to add the zero floor provisions to their syndicated loans.

“Libor negative is a threat to Libor anywhere,” said a second banker. “So that’s why we’re incorporating it.”

Deals renewed in the last year and a half are likely to already include the language. Those that haven’t been redone in the last few years are apt to see the provision added.

Electricity provider Florida Power & Light recently refinanced a US$500m three-year revolving credit facility. In the process, a Zero Libor provision was added by bank request.

When aircraft manufacturer Boeing entered into US$5bn in credit facilities late last year, the credit agreements included Zero Libor language.

“I think it’s probably become a fixture…people are going to look for it whether it’s actually needed or not,” said a second lawyer.

Reporting by Karen Schwartz; Editing By Michelle Sierra, Lynn Adler and Chris Mangham

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