JPMorgan’s Seal of Approval Gives Huge Boost to Libor’s Replacement
(Bloomberg) -- As finance milestones go, what happened Tuesday in the U.S. leveraged-loan market isn’t going to catch fire in the public consciousness. This is not the Dow Jones Industrial Average hitting some five-digit number for the first time.
But the announcement of a new loan offering tied to the Secured Overnight Financing Rate, or SOFR, is a huge moment for Wall Street. It raises hopes that the leveraged-loan market is finally making a real attempt to ditch Libor, like other parts of the financial markets -- such as derivatives and investment-grade bonds -- where far more progress has been made over the past few months, or even years.
The bank marketing the loan, JPMorgan Chase & Co., has enormous clout. Its embrace of SOFR on behalf of a customer could finally break the logjam that’s prevented borrowers from using SOFR -- the rate regulators want as the U.S. replacement for Libor, the disgraced benchmark that can no longer be tied to new loans and other financial products sold after New Year’s Eve. Existing loans will be able to reference Libor through mid-2023.
The deal “should help to set a precedent and encourage other lenders to quickly move to offering more SOFR loans,” said Tom Wipf, chairman of the Alternative Reference Rates Committee, the Federal Reserve-backed body guiding the transition.
For months, finance pros have waited for SOFR deals in the $1.2 trillion leveraged loan market. Instead they were met with silence, and nothing to suggest the new rate was going to be battle tested in time. Now, with Tuesday’s deal, there’s suddenly greater confidence that other companies will step forward with similar offerings.
“There is no more time,” Federal Reserve Governor Randal Quarles said Tuesday at a conference in Las Vegas. “Banks will not find Libor available to use after year-end no matter how unhappy they may be with their options to replace it.”
Real estate lending company Walker & Dunlop Inc. is the guinea pig, through a $600 million leveraged loan deal led by JPMorgan. Its offering will use so-called term SOFR, according to people with knowledge of the matter. The company is also an ideal candidate to be a first mover since it’s already using SOFR for mortgages, said one of the people, who asked not to be identified discussing a private transaction.
Representatives for JPMorgan and the company declined to comment.
Leveraged loans are a vital part of the funding realm for some of the world’s most heavily-indebted companies -- so nerves had been growing about the impasse. The acquisition of chicken processing company Sanderson Farms Inc. will be funded with a loan that shifts to SOFR in 2022. But it’ll rely on Libor at first, unlike Walker & Dunlop which is unlinked to Libor from the beginning.
Walker & Dunlop “is an important milestone for two reasons,” said Anne Beaumont, a partner at law firm Friedman Kaplan Seiler & Adelman LLP. “It doesn’t rely on fallback language to shift to SOFR down the line, using SOFR from day one, and because it involves non-bank lenders, who have been slow to start using SOFR.”
‘Tip of the Iceberg’
Expect many SOFR loans in the coming months, said Meredith Coffey, executive vice president of research and public policy at the Loan Syndications and Trading Association.
“This is the tip of the iceberg,” she said. “It’s important for the leveraged loan market because we have to get off Libor. We have to get to a replacement rate.”
JPMorgan tops Bloomberg’s league table for U.S. leveraged loan sales this year. That means it has the potential to set the standard for how others will structure SOFR-based loans.
Companies have been dealing with a “first-mover disadvantage” because whoever went first would be testing the waters of the market in terms of how spreads and adjustments would be determined, said Steve Hasnain, a portfolio manager at PineBridge Investments who invests in leveraged loans.
“The pace of SOFR-tied loan issuance is expected to pick up for the rest of the year,” he added.
It took months of work to ready the leveraged loan market for this switch.
Acceptance of SOFR was impeded partly by the lack of tenors beyond a day, whereas Libor has versions going up to a year. Bankers, companies and investors had been waiting for the ARRC to ratify one-, three- and six-month versions of SOFR. That occurred on July 29 -- but there’s mostly been silence since then.
Another obstacle: anyone wanting to embed a SOFR rate beyond a single day in a deal had to get a license from CME Group Inc., the administrator. CME has already issued dozens of those licenses, and has hundreds more in the works, said Agha Mirza, the company’s global head of rates and OTC products.
Another quirk for banks and companies holding up the transition was how to structure the pricing. Notably, Walker & Dunlop’s loan has two key elements to its SOFR loan that investors are closely watching.
First, the company is using a “credit spread adjustment” of 10 basis points -- which is lower than a special set of adjustments provided by regulators to assist with the transition.
Second, the loan also has a 50-basis-point floor. That means even if SOFR is below 0.5%, investors still get paid at least half a percentage point in interest, in addition to the spread.
Ultimately, how JPMorgan markets this deal and investors receive it could set the tone, and structure, for future SOFR loans.
“We’re at the start of a healthy phase of price discovery,” said Steven Abrahams, a senior managing director at Amherst Pierpont Securities.
©2021 Bloomberg L.P.