Big Milestone in Libor Demise Has Barely Budged the Loan Market

(Bloomberg) -- The next major milestone in Libor’s years-long demise is only 3 1/2 months away, but the vital loan market has done very little to show it’s ready.

After Dec. 31, new financial products can’t be tied to the London interbank offered rate, a consequence of regulators wanting to extinguish Libor following a rigging scandal a decade ago.

The leading heir for U.S. dollar loans, the Secured Overnight Financing Rate, has so far gotten little traction. Ford Motor Co. is doing the first syndicated U.S. corporate loan linked to SOFR, while the acquisition of chicken processing company Sanderson Farms Inc. will be funded with a loan that initially uses Libor but will automatically shift to SOFR in 2022.

That’s largely it for prominent new deals. 

The slow process may be due in part to cost differences when selling debt tied to each benchmark. Investors are especially waiting to see how the $1.2 trillion leveraged loan market makes the switch with delays preventing corporate borrowers from getting a dry run with SOFR before Libor ends. That raises the possibility of widespread confusion in the market come January.

“One of our main concerns about the transition is a worry that we’ve had for a while now: inertia in the loan market, especially the syndicated loan market,” Michael Held, an executive vice president at the New York Federal Reserve, said this week. “Lending in alternative rates is not where it should be at this point.”

Derivatives Leading

It’s not all gloom and doom. Trading in SOFR derivatives rose to 12.5% of the dollar-linked market in August from 7.4% in July, according to the International Swaps and Derivatives Association. The rest was in Libor contracts.

While still relatively tiny compared with the incumbent, signs of life in SOFR derivatives at least show the ecosystem for the alternative is picking up. This could help SOFR lending take off, since lenders like to manage their risks by using a derivatives market.

“For banks to feel comfortable making SOFR loans, they also have to be confident in the SOFR derivative infrastructure,” said Gennadiy Goldberg, senior U.S. rates strategist at TD Securities. “The SOFR derivatives market received an enormous boost in August,” he added. “Banks are certainly busy making the transition as we speak.”

That said, at least $976 billion of loans are unprepared for a smooth exit from dollar Libor, leaving banks and borrowers to hammer out a solution for most of them before the rate fully expires in mid-2023, according to estimates from research firm Covenant Review.

Libor Countdown: Uncertainty Awaits Nearly $1 Trillion of Loans

As far as new loan sales go, 92% of deals in August had hardwired fall-back language, according to Covenant Review. Yet 80% or so of leveraged deals in a key $1.2 trillion index lack such language from the Alternative Reference Rates Committee designed to shift them automatically to replacement benchmarks, Ian Walker, head of legal innovation at the firm, wrote in a July note. That leaves them facing an uncertain legal future when the benchmark ends, with challenges expected as companies look to refinance their debt.

There are other reasons for slow progress, said ING strategist Padhraic Garvey. He added that official endorsement of term SOFR -- or versions of the rate with tenors beyond overnight -- arrived relatively late and a dominant rate to replace dollar Libor hasn’t yet emerged.

“Should the regulator come in harder? I’d suggest that should be saved until Jan. 1, 2022,” he said. “From that date there are no excuses, but for now there are many.”

U.S.

Home furnishings company Springs Window Fashions is one of four borrowers with loan commitments due Friday.

• Barclays Plc no longer finds BB rated debt cheap and now have a preference for single Bs
  • The relative tightness of BBs also makes the prospects of further junk/high-grade compression in the cash market more limited, strategist Bradley Rogoff said
• Chinese junk-dollar bonds dropped to the lowest in a decade as Evergrande’s distress continued to send shockwaves through the market for junk debt from the nation
• Coinbase Global Inc.’s inaugural bond offering got a thumbs down in the secondary market even after there was strong demand for the debt sale
• Barclays Plc has named Chris Martinelli and Michael Neumann as co-heads of U.S. credit distribution, according to a person with knowledge of the matter
• For deal updates, click here for the New Issue Monitor
• For more, click here for the Credit Daybook Americas

Europe

The European primary market cooled on Friday after the busy week, with just four borrowers looking to issue around 3.17 billion euros worth of debt across seven tranches. That’s compared to 16 issuers on Thursday. 

• Monte Paschi’s subordinated bond fell to the lowest price this year, having plunged by more than 11 cents on the euro since Sept. 6
• SMCP SA shares gained 10% this week ahead of the maturity of exchangeable bonds issued by a subsidiary of controlling shareholder Shandong Ruyi

Asia

Industrial & Commercial Bank of China Ltd. sold $6.16 billion of a riskier type of debt in the offshore bond market, at a time when such notes are seeing robust demand in Europe.

• As a potential restructuring for Evergrande edges closer to reality, its bondholders will face an unprecedented challenge advocating for their interests
• Chinese high-yield dollar bonds fell as much as 1.5 cents Friday morning, according to credit traders, with property firms again among the leading decliners.
• Wynn Resorts Ltd. obtained a $1.5 billion credit line from Bank of China Ltd., with casino stocks under pressure amid concerns over increased government oversight in Macau
• Deal flow in the Asian dollar bond market slowed to a trickle on Friday after one of the busiest weeks of the year, with borrowers from around the Asia Pacific region pricing more than $26 billion of U.S. currency notes this week

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