Posternak Blankstein & Lund LLP is now Arent Fox. Read the press release

LIBOR Transition: Potential Higher Interest Rates and Resultant Job Cuts

How challenging is LIBOR Transition proving to be in the US structured finance market?
On
Piece of Cake 4%
Not too bad, we have most of it figured out 35%
Send questions to my legal team 29%
'Nightmare on Elm Street’ 32%

 

Lack of LIBOR Transition Details

Like street-corner proselytizers holding signs warning “The End is Near,” world markets, banks, and other financial institutions have been preaching preparedness for LIBOR’s early demise in the US. However, a great percentage of large and small businesses, the important end-users, remain in the dark with respect to details: credit-sensitive replacement rates, spread adjustments, and logistics by the very banks and financial institutions they borrow from which are insisting “The End is Near.”

Significant Financial Ramifications

The Alternative Reference Rates Committee (ARRC) has repeatedly warned that the end of LIBOR poses a financial stability risk as well as a risk to individual companies with LIBOR exposures  According to national corporate representatives:

  • Main Street borrowers need to be no worse off when SOFR becomes fully adopted. 
  • Otherwise, borrowers and issuers will bear higher interest and financing costs.
  • Which could ultimately result in cost-cutting elsewhere, including potential job cuts. [2]

Regulators agree and have insisted that the transition from LIBOR not be an excuse to increase effective interest rates on borrowers and issuers.

In a recent S&P Global Ratings analysis, depending upon the scenario utilized, an improper LIBOR transition could lead to a downgrade of 1-2 notches in the US collateralized loan obligation (CLO) market ranging from 2-10% for ‘A’ rated transactions to 5-19% for ‘BB’ rated transactions.[3]

Individual Company Feedback

Fashion company PVH Corp., chocolate maker Hershey, footwear retailer Genesco, Inc., and sports apparel maker Under Armour[4] are among approximately 100 members, public and non-public companies, investors, and borrowers of ARRC’s Non-Financial Corporates Working Group (the “ARRC Corporation Working Group”).[5] The ARRC Corporation Working Group’s members currently struggle in obtaining from their lenders specific proposals and processes for how their loan agreements will be amended.[6] Fully two-thirds of these companies have been unable to receive detailed proposals or timelines for implementation from their bankers.[7]

A survey taken among the ARRC Corporation Working Group reported that, while about 90% of the companies wish to be offered SOFR based rates (in either arrears or future options) and would prefer to borrow now using SOFR rates, nearly 70% of them are not being offered SOFR or other non-LIBOR borrowing rates by their banks.[8] In spite of the Federal Reserve’s warnings that LIBOR is about to disappear for good, these same banks are generally not discussing potential alternative rate choices with their borrowers.[9]

Operational, Technological, Accounting, Tax, and Legal Concerns

On April 27, 2021, three (3) associations – Association for Financial Professionals, National Association of Corporate Treasurers, and Center for Capital Markets Competitiveness, sent the Corporate Representatives Letter to Janet Yellen (US Treasury Secretary), Jerome Powell (Federal Reserve Chairman), John Williams (New York Fed President), Gary Gensler (SEC Chairman) and Rostin Benham (CFTC Acting Chairman) imploring their attention as they face “considerable operational, technological, accounting, tax and legal challenges”[10] caused by lenders that have yet to deliver clear alternatives to LIBOR.[11]

“We are continuing to push on a rope with our lead bank,” said Matt Johnson, Genesco, Inc. Treasurer. Referencing her fellow corporate peers who are waiting for clarity and guidance from the lending community, Jennifer Herdin, VP, Corporate Treasurer, PVH Corp., said “Nobody wants to go first.” Ms. Herdin reports seeing a lot of alternatives but finds that alternatives alone do not help implement system changes –  particularly when there are multiple currencies, multiple lenders and multiple loan maturities, and no clear direction from lenders as to what will replace LIBOR, or how, or what it will cost.[12]

As the end of LIBOR fast approaches, major banks continue to offer LIBOR-only-based loans despite the insistence by regulators that banks stop offering LIBOR-based products as soon as possible. However, as part of the transition, the banks are locking in LIBOR, with their ‘industry-standard’ documents, for potentially the entire period that no new LIBOR instruments are supposed to be offered – January 1, 2022 to June 30, 2023.

In addition, the ARRC Corporation Working Group members are still unable to negotiate current access to SOFR borrowings, even with large multi-year credit agreements nearing renewal.[13]

Sample Business Challenges

In the Corporate Representatives Letter, some real-world concerns are raised, two of which are summarized below:

Supply Chain

An international company negotiates to obtain 100% of a certain needed commodity from one supplier in exchange for a discount, which discount is normally paid up-front in anticipation of annual targeted purchases. If the purchase target is missed, the discount must be repaid. However, the formula for repayment may be LIBOR-based.

With no LIBOR, negotiations must then begin. Hopefully, delivery of the commodity is not suspended as the parties negotiate, essentially stopping the company’s operations. If the parties cannot resolve, the disadvantaged party will no doubt turn to the courts. As the case drags on, the commodity’s price has increased, decreased, or quantities are strained or over-abundant.

Delivery Delays

A large publisher contracts to purchase a huge printing press costing several hundred million dollars. The machine takes more than 3 years to manufacture. Periodic payments are due at certain construction milestones. If manufacture is delayed and a manufacturing milestone is missed, the contract provides for a reduction of the contract price. But what is the discount if the transaction is based on LIBOR, what rate is used and who decides the rate?

Particularly Impacted Transactions and Additional Operational Issues

Set forth below is a sample list of the kinds of transactions and the complex operational issues at stake:

  • Transactions with limited contact with counterparties – where consent is required by all lenders for any amendments
    • Syndicated Term Loans (syndicate lenders or institutional investors)
    • Variable Rate Notes and/or Bonds (publicly offered, banks and/or institutional investors)
    • Securitizations of business inventories or receivables (investors)
  • Internal Operations
    • Inter- and intra-company loans for cash management purposes
    • Accounting issues, determining the fair value of contracts, leases, derivatives, and capitalization of interest

Conclusion

“Let me be clear,” said Randal K. Quarles, Fed Reserve Board Vice-Chair for Supervision. “There is no scenario in which a panel-based US Dollar LIBOR will continue past June of 2023.”[14] In addition, regulators have asked that no new LIBOR instruments be entered into after December 2021.

What Main Street borrowers and issuers want is immediate clarity. The lack of LIBOR transition information from the financial world has put needed changes to corporate finances and operations on hold or in flux. When information is forthcoming, will there be enough time for Main Street borrowers and issuers to adjust?

As it is, the UK and the rest of the world are almost two years ahead of the LIBOR transition in the US – will we ever catch up?

 

[1] Survey question and responses from S&P Global Ratings’ “Structured Finance Summer Series: What Comes Next? – LIBOR Transition in Structured Finance” held on June 24, 2021 (the “S&P LIBOR Transition Seminar”).

[2] Letter re “Transitions to Secured Overnight Financing Rate – The Views of Nonfinancial Corporations,” dated April 27, 2021, from Association for Financial Professionals, National Association of Corporate Treasurers, and Center for Capital Markets Competitiveness, to Messrs. Jerome Powell, John William, Gary Gensler, Rostin Behnam, and Ms. Janet Yellen (the “Corporate Representatives Letter”).

[3] S&P LIBOR Transition Seminar. 

[4]Neil Roland, “US Companies Clamoring for Standardized SOFR Rate to ease their LIBOR systems’ transition,” 02 April 2021. 

[5] It should be noted that the AARC Corporation Working Group was only announced in December 2020 even though ARRC has been in existence since 2014. Even though the LIBOR transition is supposed to be completely transparent, the names of the members of ARRC’s Corporation Working Group are “kept confidential,” as the ARRC Secretariat advised us last week. 

[6] See the Corporate Representatives Letter.

[7] Id. 

[8] Id. 

[9] Id. 

[10] Id.

[11] Even though the LIBOR transition is supposed to be completely transparent, it is interesting to note that the April 27 Corporate Representatives Letter was only first included in ARRC’s May 2021 minutes, which were not published until mid-June.

[12] Neil Roland, Footnote No. 4which also relates to the previous industry representative quotes. It has been our experience that the financial institutions are also not eager to ‘go first’ in the LIBOR transition process.

[13] Id.

[14] “Federal Reserve Panel Discussion on Libor Transition Concludes, We Need Standardization Fast” March 30, 2021, Association for Financial Professionals.

Contacts

Continue Reading