March 4, 2020 / 10:45 PM / a month ago

Investors push for Libor floors as benchmark falls amid virus fears

NEW YORK (LPC) - US leveraged loan investors are pushing to set a minimum return for lending to some of the world’s most well-known companies as rates fall amid global market volatility caused by concerns about the fast-spreading coronavirus.

Duff & Phelps and Kissner Group were among companies that added a so-called ‘Libor floor,’ the minimum rate a key lending benchmark can be set at, to its financing packages this week to ensure a base return for investors, according to sources. Three-month Libor, the rate companies often peg interest payments to, has fallen 47% this year.

Libor fell sharply after the Federal Reserve (Fed) stepped in to cut interest rates by 50bp on Tuesday to try and contain the fallout from the virus. While a boon for borrowers that can lower their interest payments, the drop can hurt lenders who receive less compensation for their risk.

Introduced during the credit crisis as an antidote to a plunging London interbank offered rate (Libor), market participants began to push for the removal of floors when the benchmark started to bounce back and inch closer to 1%, the level of many floors.

Three-month Libor dropped to about 100bp Wednesday following the Fed emergency rate cut after starting the year at 190bp.

“While markets had widely anticipated that cuts would be forthcoming, the timing of the cut, just a couple of weeks before the Fed’s regularly scheduled meeting, sent a strong message that it views the risks as highly elevated — and that it remains prepared to act if conditions deteriorate,” Steven Oh, global head of credit and fixed income at PineBridge Investments, said in note posted to the firms’ website.

As Libor fell and volatility picked up last week — the Dow Jones Industrial Average dropped more than 12% and the LPC 100, a cohort of the 100 most liquid US loans, fell almost 2% — investors sought more protections, including floors, in exchange for providing credit.

More than 17% of loans issued in February included a 1% Libor floor, up from 14.47% in January, according to Refinitiv LPC data.

Salt supplier Kissner, corporate financial advisor Duff & Phelps and pump and compressor manufacturer Sundyne this week all added 1% Libor floors to debt packages to back their acquisitions.

Company representatives either did not return calls or could not immediately comment.

SQUEEZED CLOS

Collateralized Loan Obligations (CLOs) are the largest investors in the US$1.2trn US leveraged loan market, and in the aftermath of the financial crisis, Libor floors helped boost equity returns. When Libor sat around 25bp, 1% floors contributed about 7.5 percentage points of extra annual cash payments to the fund’s most junior investors, Morgan Stanley previously said.

The funds pool loans of different credit quality and sell slices of varying seniority, from Triple A to B, to investors including insurance companies and banks, which are paid a spread over Libor. Equity holders, which own the most junior portion of the CLO, are paid last with interest left over after bondholders receive their distributions.

Falling Libor coupled with companies cutting interest payments on more than US$151bn of loans in the first two months of 2020, about 70% of deal flow, ate into CLO distributions leaving less for the equity.

“Equity holders are still feeling the pressure of squeezed spreads and that is not going to be alleviated through refinancings or resets until spreads return to normal levels,” said Jason Merrill, an investment specialist at Penn Mutual Asset Management.

Welcoming conditions at the start of the year prompted equity investors to take advantage of the early 2020 loan repricing wave to refinance CLO debt tranches and cut expenses, which would increase their payouts. But with spreads widening amidst the market volatility, that option is now off the table, he said.

Complicating the issue is that Libor is set to be phased out at the end of next year.

Until the market transitions to a replacement, investors say they will continue to push for Libor floors on new deals.

“I expect floored loans to be in fashion this spring,” a portfolio manager said.

Reporting by Kristen Haunss; Editing by Michelle Sierra

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