October 11, 2019 / 4:58 PM / 9 days ago

CLO managers face hurdles as they try to adjust Libor language in refinancings

NEW YORK, Oct 11 (LPC) - As the clock continues to tick closer to the end of a benchmark trillions of dollars of investments rely on, some US Collateralized Loan Obligation (CLO) managers are trying to proactively encourage all fund investors to agree on a path forward.

American Money Management Corp (AMMC) is among managers that has sought to add new Libor fallback language as part of partial refinancings, even to those tranches not being reworked, ahead of the demise of Libor at the end of 2021, according to sources.

In some deals, so-called “springing” Libor language was added to the non-refinanced tranches that could allow the fallback language to take effect if a non-consenting lender changed its mind or sold the tranche.

While some investors are on board with proactively addressing Libor concerns, which could make deals easier to sell in the future, other debtholders won’t agree to the change without getting something in return.

“There is no perfect solution at the moment,” Neil Weidner, a partner at law firm Cadwalader, Wickersham & Taft, said about refinancing and adding in hardwired Libor fallback language, noting each proposal depends on the investors involved and which classes of the CLO are being refinanced.

“The question is: how do you get comfortable with the language? That is the state of play of where the market is.”

Markets have been debating the best way to move away from Libor since Andrew Bailey, chief executive officer of the UK’s Financial Conduct Authority (FCA), in 2017 said the benchmark needed to be phased out by the end of 2021.

Bailey’s announcement threw documents for both the US$1.2trn US leveraged loan market and the US$649bn US CLO market into question, with companies and managers jockeying to ensure their positions are not altered by a change in rate.

“From our perspective, we recognize that this is an enormous systemic change to market infrastructure,” Peter Phelan, deputy assistant secretary for capital markets at the US Department of Treasury, said at the ABS East securitization conference in Miami in late September.

The FCA has been clear it will no longer compel banks to submit to the Libor panel after 2021 and banks have shown a reluctance to do so, he said.

“So it’s important for markets to recognize you have this dynamic.”

The loan market has been slow to adapt to the recommended Secured Overnight Financing Rate (SOFR), a broad measure of the cost of borrowing cash overnight collateralized by US Treasury securities, because there are no SOFR term options like one-month and three-month Libor, which companies peg their interest payments to.

But some CLOs have started to add securitization fallback language recommended by the Federal Reserve-convened Alternative Reference Rates Committee (ARRC) that predetermines the steps to be taken to transition away from Libor.

“It’s now almost impossible to sell a refinancing without fallback language,” said Lawrence Berkovich, a partner at law firm Allen & Overy.

The question becomes: what to do with the tranches left behind.

“Springing language is a mechanism where lenders can consent to migrate into Libor fallback language, but until the consent is received, you just have the new tranches subject to the fallback language,” he said.

An investor would not consent to adding new Libor fallback language as part of a recent refinancing of AMMC CLO 19’s three most senior tranches, according to a source. MUFG, the bank arranging the deal, told investors that it planned to add “springing” Libor replacement language to the D and E tranches, which would allow for Libor replacement language to become effective at a later date.

An AMMC spokesperson did not return a telephone call seeking comment.

In the meantime the market will continue to work through proposals for the addition of Libor fallback language.

“Is the (transition) going to be absolutely crystal clear? No,” said Weidner. But “will it ultimately become crystal clear? Yes. Will that take time as investors negotiate agreed upon fallback language? Yes.” (Reporting by Kristen Haunss; Editing by Michelle Sierra)

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