Pricing Loans With Libor Heir Looks Simpler Than Market Feared
(Bloomberg) -- Figuring out how much a leveraged loan should cost after the market’s benchmark changes looks like it will be much simpler than corporate finance pros had feared, at least for now.
Real estate lending company Walker & Dunlop Inc. on Tuesday became the first company to announce a U.S. leveraged loan tied to the Secured Overnight Financing Rate. Regulators are pushing SOFR as a replacement for the scandal-plagued London interbank offered rate, and Libor can’t be used as a benchmark for new loans starting in 2022.
The easy fix for the firm and lead arranger JPMorgan Chase & Co. was setting a minimum rate for the loan. That makes questions about different benchmarks largely moot until short-term rates start to rise. Walker & Dunlop will pay at least 0.5% interest on its new seven-year loan, even if SOFR is below that level.
Right now, SOFR is far below that minimum: The one-month version of the rate is just 0.059%, or 5.9 basis points, after the Federal Reserve cut interest rates close to zero at the start of the pandemic. Whenever rates do rise enough, Walker & Dunlop will pay SOFR plus a “credit spread adjustment” of 10 basis points, along with some additional interest known as a spread that hasn’t yet been determined. (Investors may still push for some changes in the terms of the deal, which is due to be sold in the middle of next week.)
The credit spread adjustment is meant to turn SOFR into something approximating Libor, so investors and companies can see the spread and understand the loan’s pricing quickly. The appropriate size of this adjustment has been vexing corporate finance professionals for years, because SOFR and Libor are calculated differently and don’t move in lockstep.
Right now, one-month Libor is 8.6 basis points, or just 2.7 basis points above its SOFR counterpart. Regulators recommended that firms use a five-year average of around 11.4 basis points as a credit spread adjustment when existing loans based on one-month Libor make the transition.
Two companies, Ford Motor Co. and Boeing Co., have recently used that suggested difference for new bank lines known as revolving credit facilities.
Walker & Dunlop’s adjustment is slightly lower but still well above the current difference in rates. But that doesn’t matter for now thanks to the 50 basis point floor. Leveraged loans already use floors for Libor loans: About 78% of new first-lien leveraged loans sold in 2021 have a floor of more than 0, according to Bloomberg data.
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