Blazing demand for leveraged loans is allowing companies to reduce borrowing costs by tinkering with a provision many viewed as key to weaning the industry off Libor.
U.S. leveraged loans are shifting to a new rate benchmark known as the Secured Overnight Financing Rate. Unlike its predecessor, Libor, SOFR does not tend to spike when credit markets get stressed — a potential
But demand for loans is incredibly high at the moment as the Federal Reserve prepares to hike interest rates, and that’s given borrowers and their banks leeway to remove the CSA or have the same CSA across all tenors, instead of offering a higher rate for longer terms.
“There is a lot of money looking to be invested in loans, so borrowers have the upper hand, including with respect to Libor transition,” said Meredith Coffey, executive vice president of research and public policy at the Loan Syndications and Trading Association.
When JPMorgan Chase launched a $4.4 billion SOFR loan for software maker McAfee’s buyout, the pricing was proposed with a flat adjustment of 10 basis points for one, three and six months. About $2.7 billion of loans priced last week with a similar structure, led by either Credit Suisse Group or Bank of America.
It’s a major contrast with how things worked just a few months ago. In October, investors scored a win by pushing back on the CSA for Walker & Dunlop’s $600 million loan, which many thought would set the standard for SOFR loans. It added a 10-basis-point CSA for one month, 15 basis points for three months and 25 basis points for six months.
Leveraged loan investors are now looking like the losers in the $1.3 trillion market’s transition away from the discredited Libor. The whittling down of CSAs shows the balance struck last fall was an uneasy one and underscores how much investors have weakened their position as a result of their seemingly insatiable demand for leveraged loans as the Fed
“So far, the majority of SOFR based primary loan issuance has been based on a 10/15/25 CSA construct. In the past week however, we have seen two of the larger transactions in the market, Tropicana and McAfee, announce flat adjustments of 10 basis points regardless of term,” said Roberta Goss, senior managing director and head of the bank loan and CLO platform at Pretium Partners LLC. “We expect the market to continue to move in this direction as the timing of Fed rate hikes becomes clearer over the coming months.”
Issuers are sometimes adding clauses to deals that stipulate if other borrowers issue their own loans with better CSA terms, their loan will automatically shift to those, according to people familiar with the matter who aren’t authorized to speak publicly.
Some loans don’t have a separate CSA, instead incorporating it within the traditional spread that floats above the benchmark. Without an explicitly stated CSA, these loans may see more volatile prices; when there’s less transparency, there’s often more turbulent trading, according to a report from Bank of America.
In addition, Bank of America says some deals have no CSA whatsoever, and the spread is the same as if the loan had used Libor. “In these cases there is an unmistakable transfer of value from investors to issuers,” credit strategist Neha Khoda wrote in a report.
The use of multiple CSA structures in the market shows that issuers still have a fair amount of discretion, said Tal Reback, who leads the Libor transition at KKR.
“This is a lever being used in the price discovery process, which begs the question, should new risk just be priced differently?” Reback said. “Going forward, I strongly believe the significance of what a credit spread adjustment represents will diminish in value.”
